Definition
A home equity loan is a type of second mortgage that allows homeowners to borrow a lump sum of money using their home's equity as collateral. Unlike a HELOC which provides a revolving line of credit, a home equity loan gives you all the money upfront in one payment, which you then repay over a fixed term (typically 5-30 years) with fixed monthly payments at a fixed interest rate.
The loan amount is based on your home equity — the difference between your home's current market value and what you still owe on your primary mortgage. Most lenders allow you to borrow up to 80-85% of your home's value minus your existing mortgage balance. For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, you might qualify for a home equity loan of up to $100,000 (80% of $500,000 = $400,000, minus the $300,000 you owe).
Home equity loans are popular for major expenses like home renovations, debt consolidation, or large purchases because they typically offer lower interest rates than credit cards or personal loans. However, your home serves as collateral, meaning you could lose it if you fail to make payments.
How It Applies to HELOCs
A home equity loan differs significantly from a HELOC (Home Equity Line of Credit) in how you access and repay the money. While both use your home's equity as collateral, a home equity loan provides a lump sum payment with fixed monthly payments, whereas a HELOC works like a credit card with a draw period (usually 10 years) during which you can borrow and repay funds as needed, followed by a repayment period.
Many homeowners choose between these options based on their needs: a home equity loan works better for one-time expenses with known costs (like a $50,000 kitchen renovation), while a HELOC is more flexible for ongoing projects or expenses where the total amount isn't certain upfront. Home equity loans also offer the predictability of fixed interest rates, while HELOCs typically have variable rates that can change over time.
How It Applies to DSCR Loans
For real estate investors, home equity loans can serve as a source of capital for acquiring investment properties, though they're less common than DSCR loans for this purpose. An investor might use a home equity loan on their primary residence to fund a down payment on a rental property, then later refinance the investment property with a DSCR loan based on the rental income.
Unlike DSCR loans which qualify borrowers based on the investment property's debt service coverage ratio (rental income vs. mortgage payments), home equity loans are underwritten based on the borrower's personal income and credit profile. However, investors should be cautious about using their primary residence as collateral for investment purposes, as this puts their home at risk if the investment doesn't perform as expected.
Example Calculation
Home Equity Loan Calculation Example:
Sarah owns a home worth $600,000 with a remaining mortgage balance of $350,000. She wants a home equity loan for a $75,000 kitchen renovation.
Step 1: Calculate available equity
- Home value: $600,000
- Mortgage balance: $350,000
- Current equity: $600,000 - $350,000 = $250,000
Step 2: Determine maximum loan amount (80% LTV)
- Maximum total debt: $600,000 × 80% = $480,000
- Existing mortgage: $350,000
- Maximum home equity loan: $480,000 - $350,000 = $130,000
Step 3: Calculate monthly payment for $75,000 loan
- Loan amount: $75,000
- Interest rate: 8.5% (fixed)
- Term: 15 years
- Monthly payment: $738
Sarah qualifies for up to $130,000 but only needs $75,000, giving her a comfortable equity cushion.
Explore More Financial Terms
Build your financial literacy with our complete glossary of HELOC, mortgage, and investing terms.
Browse All Terms→