The pros and cons of home equity loans

If you’re a homeowner and need cash to cover a home improvement project or to consolidate debt, a home equity loan could be the right financing option. A home equity loan is a second mortgage that allows you to borrow against your home equity using your home as collateral. 

By securing the loan with home equity, you can get access to a lower interest rate. However, it also means that the bank could foreclose on your home if you’re unable to repay the loan. Here, we’ll review the pros and cons of home equity loans to help you decide if it’s the right loan option for you.

Key takeaways:

• Home equity loans can help homeowners borrow money at a lower interest rate by using their home as collateral.
• With a home equity loan, you can borrow a lump sum at a lower rate than credit cards and personal loans.
• However, because you’re using your home to secure the loan, you could risk foreclosure if you can’t keep up with payments.

How does a home equity loan work? 

With each mortgage payment you make, you build equity in your home. Home equity is the percentage of the home you actually own. Your equity can be calculated by taking the current value of your home and subtracting what you still owe. One way to use the equity you’ve built is by using it as a collateral to borrow money at a lower interest rate.

Home equity loans are issued as one large lump sum that are repaid at a fixed interest rate over the course of 5 – 30-year terms. You’ll typically need to have built at least 20% to get a home equity loan, and you can typically borrow up to 80% of the equity you have.

Some common uses for home equity loans include:

• Debt consolidation
• Home improvements
• Tuition
• Unexpected medical bills
• Car repairs
• Wedding

While using your home as collateral can help you save money, it also comes with increased risk. A home equity loan is a second mortgage payment that you’ll need to make each month in addition to your primary mortgage. If you can’t keep up with both payments, the bank can foreclosure on the home.

Home equity loan pros and cons at a glance

Pros of home equity loans

A home equity loan is a good option for homeowners looking for low interest rates and predictable monthly payments. Here are some of the biggest benefits of taking out a home equity loan.

Fixed interest rates 

Home equity loans come with fixed interest rates. This means your interest rate gets locked in when you close on the loan and never changes. This differs from a loan that comes with a variable interest rate, which can change with the market over the life of the loan.

Predictable payments

A major perk of a fixed interest rate is that you’ll have a predictable monthly payment as you repay the loan. You can budget for the future without worrying that your home equity loan payment might increase.

With a variable interest rate loan, your monthly payments can fluctuate when your interest rate adjusts on a regular interval. This could leave you with a higher monthly payment if market rates increase – which is not a risk with a fixed-rate loan.

Long payment periods

Home equity loans come with flexible terms that can range anywhere from 5 - 30 years. You can choose a longer loan term to give yourself more time to pay back the loan. This can also help keep your monthly payment relatively low so that you can accommodate it within your budget alongside your primary mortgage.

Lower interest rates than unsecured debt

A home equity loan is a type of secured loan because your home is used as collateral. Securing a loan reduces the risk for the lender and allows them to charge a lower interest rate. Unsecured loans - like personal loans - carry more risk for the lender and typically come with higher interest rates.

Ability to borrow large sums

Many lenders allow you to borrow up to 80% of your equity with a home equity loan. Let’s say you have a $400,000 home and you owe $100,000 on your current mortgage. That means you have $300,000 in equity and could borrow up to $240,000 of it. You can use our Rocket MortgageÒ home equity calculator to help you estimate how much equity you have in your home.

Tax deductible

The interest paid on your home equity loan is tax deductible if you use the funds to make home improvements. Plus, renovating your home can increase the value of your property.

Cons of home equity loans

Here are some of the biggest disadvantages and risks to consider before taking out a home equity loan.

Risk of foreclosure

When you take out a home equity loan, the lender places a lien on your property. Since your home is used as collateral for the loan, your lender has the legal right to foreclose on your home if you’re unable to repay it. That means you could lose your home if you struggle to keep up with payments on either your primary or second. Credit cards come with much higher interest rates, but your home isn’t at risk if you can’t repay the debt.

Closing costs

When you take out a home equity loan, you’ll have to pay closing costs. These costs include an application fee, an appraisal fee, a title search fee, and a credit report fee. Closing costs for a home equity loan typically range between 2% and 5% of the total loan amount.

Higher debt

A home equity loan ultimately must be repaid, which means it adds to your total debt on top of your primary mortgage. You’ll be reducing the amount of equity you have and increase the amount you owe.

Negative equity risks

There’s always the possibility that property values could drop, and your home could be worth less than you paid for it. If that happens after you’ve taken out this kind of loan, you could end up with negative equity and owe more on your loan than your home is worth.

Qualification constraints 

To get a home equity loan, you’ll need to meet certain eligibility criteria. While these requirements can vary based on the lender, you’ll typically need the following:

• Minimum credit score of at least 680
• DTI that does not exceed 43%
• At least 20% equity
• Proof of income

Prepayment penalties 

Some lenders charge a prepayment penalty if you pay back your loan early. The cost of a prepayment penalty can be as high as 2% of the loan amount. Before you pay of a home equity loan early, be sure to check to see if your lender charges a prepayment penalty.

Compounding interest 

Interest on a home equity loan typically compounds daily. Compounding interest means that you pay interest not only on the principal balance, but also on the interest you accumulate. As a result, your total debt grows faster.

How to apply for a home equity loan

If you think a home equity loan might be the right financing option for you, here are steps to take to get one.

1. Research and compare lenders. You don’t work with your original mortgage lender for your home equity loan, though you certainly can. Shop around to get estimates of what loan amounts and interest rates are available to you from different lenders. That way, you can be sure you’re getting the best terms you can.
2. Apply. Once you’ve landed on a lender, you’ll typically be able to apply for a home equity loan online.
3. Have your home appraised. To get a home equity loan, you’ll need to have your home appraised to determine its current fair market value. The results of the appraisal directly impact how much equity you have and how much you can borrow.
4. Complete the underwriting process. During the underwriting process, your lender will look to confirm that you can afford your second mortgage. You can expect your lender to ask for certain financial documents, including tax returns, recent W-2s, pay stubs, and bank statements.
5. Close on the loan. If your financial situation checks out and your lender issues final approval, it’s time to pay your closing costs and close on the loan.
6. Receive your loan disbursement. You’ll typically receive your home equity loan in the form of a lump sum payment 3 business days after closing.

When it makes sense (or doesn’t) to get a home equity loan

A home equity loan can be a good option if you have:

• A stable income
• Good credit
• The ability to afford a second monthly payment
• Substantial equity
• Long-term plans to stay in the home
• A reason to borrow a lump sum

On the other hand, a home equity loan might not be the right move if you have:

• An uncertain income
• A tight budget
• Low equity
• A volatile property market
• A plan to sell your home soon

Home equity loan alternatives

If you’re wary about using your home as collateral for a loan, here are four alternatives to consider:

1. Home equity line of credit (HELOC)
2. Cash-out refinance
3. Credit cards
4. Personal loans

HELOC vs. home equity loan

Both home equity loans and home equity lines of credit that allow you to use your equity as collateral to borrow money. While a home equity loan comes as a lump sum, a HELOC is a revolving line of credit you can draw from multiple times over the course of the draw period.

This flexibility makes it a good option in situations where you don’t know exactly how much you’ll need to borrow. A home equity line of credit works like a credit card, letting you borrow what you need, when you need it, with flexible payments. On the other hand, a home equity loan gives you a lump sum upfront with fixed rates and steady payments, perfect for big, one-time expenses.

Note that while home equity loans come with a fixed interest rate, HELOCs come with a variable interest rate that adjust on a regular interval.

Cash-out refinance vs. home equity loan

With a cash-out refinance, you replace your existing mortgage with a new, larger loan and withdraw the difference in cash. This is a good alternative to a home equity loan since you can access the funds you need without taking on a second mortgage and having a second monthly payment.

Cash-out refinances tend to have lower interest rates than home equity loans. If interest rates have dropped since you first took out your mortgage, a cash-out refinance can also be a way to reduce the interest rate and monthly payment on your primary mortgage. If interest rates have risen since you took out your mortgage, a home equity loan might make more sense.

Personal loan vs. home equity loan

Personal loans do not require the use of your home as collateral. While this means you don’t risk foreclosure if you can’t repay the loan, it also means you’ll be paying a higher interest rate. Personal loans tend to have lower borrowing limits and shorter repayment periods. If you’re looking to borrow a small amount with low risk, a personal loan might make more sense. If you need to borrow more and want to save on interest, a home equity loan can be a better option.

Credit card vs. home equity loan

Credit cards come with higher interest rates, but they’re also far less risky than a home equity loan when it comes to losing collateral. This option may make sense if you can qualify for a card with a 0% introductory interest rate and pay off the balance before it ends.

However, if you need to borrow a large amount and need time to pay it back, a home equity loan or HELOC can help you save significantly on interest. It can be difficult to get out from under a large amount of credit card debt, and some homeowners use a home equity loan to consolidate that debt at a lower interest rate.

The bottom line: Home equity loans can be a great financing option

Like any loan option, home equity loans come with advantages and drawbacks. Using your home as collateral can help you get a lower interest rate, but you could lose the home if you can’t repay the loan. You’ll have predictable monthly payments and can use the money you borrow on whatever you wish, but you’ll need to meet equity and eligibility requirements.

Ready to explore this option? Start an application for a Home Equity Loan from Rocket Mortgage^® today.

Home 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.

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