How a Home Equity Loan Works
A home equity loan lets you borrow a lump sum against the equity you have built in your home. Unlike a mortgage, which finances the purchase of a home, a home equity loan is a second lien — secured by the same property. You receive the funds all at once, repay them in equal monthly installments at a fixed interest rate, and the loan is fully amortized by the end of the term.
Because your home serves as collateral, home equity loans typically carry lower interest rates than personal loans or credit cards. Rates are usually 1–3 percentage points above current 30-year mortgage rates, depending on your credit profile and CLTV.
How Much Can You Borrow? The 85% CLTV Rule
Most lenders cap home equity lending at 85% of your home's combined loan-to-value (CLTV). CLTV is your total mortgage debt divided by your home's current market value. The formula for maximum borrowing is:
Maximum Loan = (Home Value × 0.85) − Existing Mortgage Balance
For example, a home worth $500,000 with a $300,000 mortgage balance gives you a maximum home equity loan of ($500,000 × 0.85) − $300,000 = $125,000. Some lenders extend to 90% CLTV for borrowers with excellent credit, but qualifying terms are stricter.
| Home Value | Mortgage Balance | Current LTV | Max Equity Loan (85%) |
|---|---|---|---|
| $300,000 | $150,000 | 50% | $105,000 |
| $400,000 | $250,000 | 62.5% | $90,000 |
| $500,000 | $300,000 | 60% | $125,000 |
| $600,000 | $400,000 | 66.7% | $110,000 |
| $750,000 | $400,000 | 53.3% | $237,500 |
Home Equity Loan vs. HELOC
Both products let you tap home equity, but they work very differently. A home equity loan is a single disbursement at a fixed rate — ideal when you know exactly how much you need (a renovation, debt consolidation, a major purchase). The fixed rate and fixed payment make budgeting straightforward.
A HELOC is a revolving credit line with a variable rate. During the draw period (typically 10 years), you borrow only what you need and pay interest only on the balance drawn. This flexibility makes HELOCs better for ongoing expenses or projects where costs are uncertain. The trade-off is rate risk: if interest rates rise, your monthly payment rises too.
Questions You Might Ask
How much can I borrow with a home equity loan?
Up to 85% of your home's combined loan-to-value, minus your existing mortgage balance. On a $500,000 home with a $300,000 mortgage, that is $125,000. Some lenders go to 90% for excellent-credit borrowers.
What is the difference between a home equity loan and a HELOC?
A home equity loan gives you a lump sum at a fixed rate. A HELOC is a revolving line at a variable rate — you draw what you need during a draw period, then repay the balance. Home equity loans are better for one-time, defined expenses; HELOCs are more flexible for ongoing needs.
Are home equity loan payments tax-deductible?
Only if the funds are used to buy, build, or substantially improve the home securing the loan. Interest used for other purposes — debt consolidation, vacations — is not deductible under current law. Consult a tax advisor for your situation.
What credit score do I need?
Most lenders require a minimum score of 620. Scores of 700 or above qualify for the best rates. Lenders also typically require a DTI below 43% and at least 15–20% equity in your home.