Is a home equity loan a good idea?

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A home equity loan¹ allows homeowners to borrow the equity they've built through their mortgage payments to pay for renovations, consolidate high-interest debts, or fund any project you like. Borrowing equity can be a powerful financial tool, but it comes with trade-offs and risks that should be carefully considered before you decide. Let’s look at how a home equity loan works, when it makes sense to get one, and when you’d be better off with other financing options.

What is home equity?

Home equity is the difference between your home's current market value and what you owe on your mortgage. You can think of home equity as the amount of your home that you own. As you pay down your principal loan balance, you build equity. Another way you can build equity is by increasing the value of your home.

For example, if your home is worth $400,000 and you still owe $250,000, you have $150,000 in equity. This equity builds over time as you make mortgage payments and as your home's value appreciates. Your equity represents your ownership stake in the property and can serve as valuable collateral for borrowing. Once you pay off the loan, you own your home free and clear, which means you can access 100% of the home equity.

What is a home equity loan, and how does it work?

A home equity loan allows you to borrow a lump sum of money using your home as collateral. Because the loan is secured by your home, you can get a lower interest rate than you would with other types of loans. However, that also means you could risk foreclosure if you cannot repay the loan.

A home equity loan is a second mortgage, which means you’ll have to make two separate monthly payments. These loans typically come with fixed interest rates and predictable monthly payments over a set period, usually 5 to 30 years. Most lenders require you to have at least 15% - 20% equity in your home, which means maintaining a loan-to-value (LTV) ratio of 75% - 80% or less.

While there are no restrictions on what you can use the funds from your home equity loan for, here are some common uses for this type of financing:

• Home improvements
• Debt consolidation
• Tuition and other education expenses
• Medical bills
• Car repairs
• Legal expenses

Things to consider before getting a home equity loan

Home equity loans allow homeowners to borrow money at a lower interest rate than many other loan types. However, there are also situations where taking out a home equity loan can create more problems than it solves.

Using borrowed funds for discretionary spending, such as vacations, luxury purchases, or everyday expenses, is rarely a wise financial decision. These nonessential uses don't build long-term value and leave you with years of additional debt.

Let’s go over some of the advantages and drawbacks of home equity loans.

Pros

Home equity loans can be a useful borrowing option for homeowners. Here are some of the perks:

• You can borrow a lump sum of money. If you’re looking to finance home renovations or need to fund tuition costs, a home equity loan can be a useful borrowing tool.
• Lower interest rates. Home equity loans typically have lower interest rates than personal loans and credit cards.
• Fixed interest rates. Home equity loans typically have fixed interest rates, so you’ll have predictable monthly payments.
• Improvements to your home may increase its value. If you're using a home equity loan to finance renovations, you could improve your quality of life and boost your home's value.
• Potential tax breaks. The interest paid on your home equity loan may be tax-deductible if you used the money to improve your home and add value.

Cons

There are also potential drawbacks to consider when deciding if a home equity loan is right for you, including:

• You could risk losing your home in a foreclosure. If you can’t keep up with a second monthly payment and default on your home equity loan, you could lose your home.
• Two mortgage payments. With a home equity loan, you’ll be paying a second mortgage in addition to your original mortgage.
• You lose home equity. Borrowing against your home equity reduces the total equity you have in your home.
• You’re at risk if home values decrease. If the value of your home decreases, you may end up owing more than the home is worth, leaving you with negative equity.
• Closing costs and fees. To get a home equity loan, you’ll have to pay closing costs that can amount to 3% – 6% of the total loan amount.

Should I get a home equity loan?

Before applying for a home equity loan, take an honest look at your financial situation and goals. Consider whether you can comfortably afford two monthly mortgage payments, even if unexpected expenses arise. Also, think about how long you plan to own your home. If you're planning to move soon, the closing costs might not be worth it.

When you apply, your lender will consider your credit score, debt-to-income ratio (DTI), and the amount of equity you have. Most lenders require a DTI below 43% and prefer borrowers with a strong payment history. You'll also need a home appraisal to confirm your property's current value and determine how much you can borrow.

Alternatives to home equity loans

If a home equity loan doesn't feel like the right fit, there are other ways to use your home equity to borrow money.

Home equity loans vs. cash-out refinance

With a cash-out refinance, you replace your existing mortgage with a new, larger loan and withdraw the difference in cash.² This option makes the most sense if current mortgage rates are comparable to or lower than your existing rate. However, if you secured a low rate when the average mortgage rate hit record lows in 2020 and 2021, replacing it with a 2026 rate might increase your overall interest costs.

Keep in mind that cash-out refinances come with full closing costs, typically 3% - 6% of the new loan amount. This adds up to between $9,000 - $18,000 on a $300,000 loan.

Home equity loans vs. personal loans

With a personal loan, you borrow money without using your home as collateral. This eliminates the risk of foreclosure if you don't repay a home equity loan. However, because they're unsecured, interest rates are typically much higher than home equity options – often in the double digits. Personal loans work best for smaller amounts and shorter repayment periods.

Home equity loans vs. credit cards

While credit cards offer quick access to funds, they usually have interest rates above 20%, making them one of the most expensive borrowing options. Credit cards make sense for very small, short-term needs that you can pay off quickly. However, credit cards are rarely a good substitute for larger home equity financing.

Home equity loans vs. HELOCs

A home equity line of credit (HELOC) is like a home equity loan in that it's a second mortgage that uses your home equity as collateral. However, while a home equity loan is a lump-sum loan, a HELOC is a revolving line of credit you can withdraw from as needed for a specific period of time.

Home equity loans are good if you have a specific budget in mind for a defined set of projects. HELOCs, on the other hand, allow you to continually access funds and repay them over and over again during the draw period as needs arise.

Rocket Mortgage currently doesn't offer HELOCs, but we want you to be aware of all your borrowing options.

FAQ

Here are answers to common questions about whether a home equity loan is a good idea.

How much can I borrow?

The amount you’re able to borrow will be based on the amount of equity you have in your home. Lenders typically let you borrow up to 80% - 90% of your home’s appraised value, minus what you still owe on the mortgage.

Is the interest on a home equity loan tax-deductible?

The interest you pay on a home equity loan can be tax-deductible if you used the loan to boost the value of the home.

How would this loan affect my credit?

A home equity loan can cause a temporary dip in your credit score for two reasons: you’re taking on more debt, and a hard inquiry on your credit report is required.

Can I use a home equity loan for anything I want?

You can use the money you borrow with a home equity loan on whatever you want. Many borrowers use a home equity loan to pay for home improvements, consolidate debt, or pay for school tuition.

What happens if I sell my home or move?

If you sell your home before you’ve paid off your home equity loan, you’ll have to pay off the outstanding balance. Borrowers typically use the proceeds of the sale to pay off their home equity loan and primary mortgage.

The bottom line: A home equity loan can work for you

Home equity loans can be a valuable tool for improving your home, consolidating debt, paying for student loans, or alleviating other financial strains on your budget. Home equity loans typically have lower interest rates than other types of loans, making them an attractive financing option.

However, the decision to use your home as collateral shouldn't be taken lightly. Make sure you have a clear plan for how you'll use the funds, confirm you can comfortably afford the payments, and understand all the risks involved.

Are you ready to get started? You can apply for a Home Equity Loan today.

¹Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 11/19/25 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00 (minimum loan amount for properties located in Michigan is $10,000.00). Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Ameriprise products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.

²Refinancing may increase finance charges over the life of the loan.

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