Things to consider before using home equity

Your home equity could help fund your next major project, consolidate high-interest debt, or cover an unexpected expense—often at a lower rate than unsecured borrowing. Before you borrow, it’s important to understand the terms, costs, and risks. Home equity borrowing lasts longer than most other types of borrowing, and your home is on the line.

Home equity is the difference between your home's current market value and what you still owe on your mortgage. Two of the most popular ways to borrow against it are a home equity loan (a one-time, fixed-rate loan) and a home equity line of credit, or HELOC (a revolving credit line).

This guide covers the advantages and disadvantages, how the two options compare, questions to ask your lender, and practical tips for borrowing wisely.

How home equity borrowing works

A home equity loan is a one-time loan secured by your home. You receive the funds at closing and repay them over a set term with fixed monthly payments. Most home equity loans carry fixed interest rates.

A HELOC works differently. With a HELOC, you can borrow, repay, and borrow again up to your credit limit during a draw period, which is followed by a repayment period. Many HELOCs carry variable interest rates that can change over time. Achieve Loans offers a fixed-rate HELOC where the rate stays the same for the entire term.

Both a home equity loan and a HELOC are mortgages. If you take one out while you still owe on your primary mortgage, the new loan is a second mortgage. Your home is used as collateral. If you don't repay the loan, the lender could foreclose on your home.

Home equity loan amounts generally range from $10,000 to $1,000,000 or more, depending on your equity, creditworthiness, and lender. Repayment periods typically range from five to 30 years, depending on your lender and the term you choose.

How much could you borrow using home equity?

Most lenders let you borrow up to 80% to 85% of your home’s value in total. This limit includes your primary mortgage and your new home equity loan or HELOC. Lenders generally set the cutoff using combined loan-to-value (CLTV) ratio.

For example, say a lender’s CLTV limit is 80%, and your home is worth $200,000. The lender would limit your total mortgage debt to $160,000 (80% of $200,000). If you owe $100,000 on your primary mortgage, then you could borrow another $60,000 using a home equity loan or HELOC from that lender.

Estimate your home value and check your current mortgage balance before contacting lenders to see how much you could borrow.

Advantages and disadvantages of home equity borrowing

Every borrowing option comes with trade-offs. One good way to evaluate a home equity loan or HELOC is to weigh the upsides against the costs and risks for your specific situation.

Potential pros of home equity loans

• Lower interest rates than unsecured debt. Home equity loans and HELOCs are secured by your home. Lenders consider real estate strong collateral because it can’t be hidden or moved, and its value tends to hold or appreciate over time. This means lenders often charge lower interest rates for home equity loans than credit cards or personal loans, because there’s less risk involved.

• Access to larger loan amounts. Depending on your equity, you could borrow tens of thousands or even hundreds of thousands of dollars, more than most unsecured options typically offer.

• Fixed-rate options provide payment predictability. Most home equity loans carry fixed interest rates, so your rate and monthly payment stay the same for the life of the loan. Some lenders, including Achieve Loans, also offer fixed-rate HELOCs. Fixed payments can also make budgeting easier.

• Potential tax benefits. Interest on a home equity loan or HELOC could be tax-deductible if you use the funds to buy, build, or substantially improve the home that secures the loan, per IRS rules. The combined mortgage debt limit for deductibility is $750,000 ($375,000 if your filing status is married filing separately). Consult a tax professional.

• Flexibility of use. You could use home equity funds for debt consolidation, home improvements, medical expenses, education costs, or other major expenses.

• Potential credit score benefits. A home equity loan could help you raise your credit score in a few ways: on-time payments support your payment history (a leading factor in your score), using the funds to consolidate credit card debt could lower your credit utilization ratio, and adding a mortgage account could improve your credit mix.

Common disadvantages of home equity loans to weigh

• Your home is collateral. Because a home equity loan or HELOC is a mortgage, your home secures the debt. If you do not repay the loan, you could face foreclosure.

• Closing costs add to the total expense. Home equity loans and HELOCs could include closing costs that range from 0% to 5% of the loan amount, including appraisal, origination, and title search fees.

• Variable rates could increase payments. Most HELOCs carry variable rates, which means your monthly payment could rise if interest rates increase. A fixed-rate option could limit that uncertainty.

• Longer approval timeline than unsecured loans. HELOCs and home equity loans require a home valuation and underwriting, which could take several weeks.

• Property value declines could affect your equity position. If your home's market value drops, so does your available equity, which could limit your borrowing power.

How home equity loan and HELOC terms differ

Home equity loans and HELOCs both use your home equity. The structure of a home equity loan vs. a HELOC differs in ways that could shape your decision.

Another difference to consider: Some lenders allow interest-only payments during the draw period for HELOCs. This could mean lower payments during the draw period but a big payment jump during the repayment period, as well as paying much more interest overall. Achieve Loans requires full principal-plus-interest payments during the draw period, so you pay down the balance from the first payment rather than deferring principal.

Questions to ask when applying for a home equity loan

Before you sign any loan agreement, ask the right questions, as they could save you money and prevent surprises:

1. What interest rate will I receive, and is it fixed or variable? Advertised rates normally reflect a narrowly defined low-risk borrower: a high credit score, a low CLTV ratio, and high income. Many applicants don't qualify for advertised rates. Find out what rate you would receive based on your specific financial profile.

2. What are the total closing costs and fees? Ask for an itemized list of all closing costs, including appraisal fees, origination fees, title search fees, and any annual fees. 

3. Is there a prepayment penalty? Some lenders charge a fee if you pay off the loan early or close the line within the first two to three years. Ask whether prepayment penalties apply and how the lender calculates them.

4. How long is the draw period and the repayment period for HELOCs? Your draw period is the period during which you can withdraw funds. It usually ranges from five to 10 years. Ask whether payments during the draw period cover principal and interest or interest only. Your repayment period starts at the end of the draw period and often lasts 10 to 20 years.

5. What documents do I need for the application? Be prepared to submit pay stubs, W-2s for wage earners, or tax returns if you are self-employed. Most lenders also require a current mortgage statement and proof of homeowners' insurance as part of their home equity loan requirements.

6. What is the maximum CLTV your lender allows? CLTV determines how much you could borrow. Lenders often cap CLTV at 80% to 85%, but some allow up to 90%.

7. Is there a right of rescission? Federal law gives you three business days after closing on a home equity loan against your primary residence to cancel the loan. Although the right of rescission is a law, it’s still a good idea to confirm with the lender that it applies to your home equity loan or HELOC. This same rule also means you also have to wait 3 days after closing before you receive your funds.

Home equity borrowing tips

Compare offers from multiple lenders

Interest rates, closing costs, and CLTV limits vary by lender. Quotes from at least three lenders help you find a strong fit. You can start by getting prequalifications, where you provide basic details to lenders and see what kind of terms you could qualify for. Prequalification typically only involves a soft credit inquiry, which doesn’t affect your credit score.

When you’re ready to get firmer offers, you can go through the preapproval process. A preapproval could give you a more accurate idea of potential loan terms. It also usually requires a hard credit inquiry, which can impact your credit score. Fortunately, multiple hard inquiries from mortgage lenders made within 14 to 45 days normally count as a single inquiry for scoring purposes. This allows people to shop around without too much of an impact on their credit.

Understand your debt-to-income (DTI) ratio

Your DTI ratio equals your total monthly debt payments divided by your gross (pre-tax) monthly income. The maximum DTI ratio for a home equity loan or HELOC is typically between 43% and 50%, depending on the lender. A lower DTI could help you secure better rates and higher loan amounts.

Borrow only what you need

Calculate the total cost of borrowing, including interest and closing costs, before deciding how much to borrow. A larger loan than necessary could increase the amount you need to repay, which means more interest fees and payments that could strain your monthly budget.

Have a repayment plan before you borrow

A home equity loan or HELOC payment comes on top of your existing mortgage payment. Factor the new monthly payment into your budget alongside your insurance and taxes, and confirm you can comfortably handle them before you apply. 

While longer repayment terms lower the monthly payment, they also raise the total interest you pay. Choose the shortest term you can afford to keep costs down.

How Achieve Loans could help

HELOCs through Achieve Loans are built for homeowners who want predictable payments and straightforward terms:

• Fixed interest rate. Most HELOCs carry variable rates. Achieve Loans offers a fixed rate, so your payment stays predictable.

• Full principal-plus-interest payments during the draw period. You pay down the balance from your first payment rather than deferring principal. This could save you money in the long run compared to interest-only payments.

Find out if you qualify with Achieve Loans.