How a Home Equity Loan Works

If you need funds to finance life’s major expenses, a wise alternative would be to tap into your home’s equity. One way of doing so is to have a home equity loan.

You can take advantage of rising house prices and do not need to sell your home to cash in. An increasing number of homeowners are pulling money out of their homes as real estate prices increase worldwide.

Next is what a home equity loan is, how it works, and its benefits and drawbacks. Keep reading to learn if you want to know if this financial move is practical for you.

How a Home Equity Loan Works
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What Is a Home Equity Loan?

A home equity loan – also called equity loan, home equity installment loan, or second mortgage – is a form of consumer debt. Home equity loans enable homeowners to borrow against their home equity.

The loan cost is determined by the difference between the home’s current market value and the due mortgage balance of the homeowner. Home equity loans tend to be fixed-rate, while the usual substitute, home equity lines of credit (HELOCs), are usually flexible.

How Do Home Equity Loans Work?

It functions like the way your first mortgage did when you first acquired your home. The loan money is disbursed as a lump sum, so you can use it as you feel necessary. 

You start making fixed, monthly payments to pay back the loan once you received it. Home equity loans come in two varieties, fixed-rate loans and revolving lines of credit.

Fixed-Rate Loans

Fixed-rate loans offer the borrower with a single, lump-sum payment. It is paid at an agreed-upon interest rate for a fixed time, typically five to 15 years. 

For the duration of the loan, the payment and interest rate remain the same. When the home on which it is based is sold, the loan must be repaid in full.

Home Equity Lines of Credit (HELOCs)

A HELOC is a flexible, or variable-rate loan that operates just like a credit card and, in general, often deals with one to use on the line of credit purchases. 

Borrowers are pre-approved for a specified spending limit and can withdraw money via credit card or special checks if they need it. Monthly payments differ according to the amount of borrowed money and the present interest rate.

How a Home Equity Loan Works
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Home equity loans provide a quick money source and can be advantageous instruments for responsible borrowers. The interest rate on a home equity loan is much lower than that on credit cards and other consumer loans, though higher than that of a first mortgage.

Home equity loans are typically a better option if you thoroughly know how much to borrow and where you will use the money. A specific amount is guaranteed to you, which you obtain in full at closing.


The biggest issue with home equity loans is that they may appear to be an all-too-easy option for a borrower who may have slipped into an endless cycle of spending, borrowing, spending, and further debt sinking.

There might be some temptation to borrow more than you need initially when applying for a home equity loan, as you only get the payout once, and you don’t know if you’re eligible for another loan in the future. That could turn into a downward road to default and foreclosure.

The Bottom Line

The necessities of life are food, clothing, and shelter, but only shelter can be leveraged for cash. No financial transaction is entirely risk-free and taking a loan, particularly one concerning your home, is a tough matter.

Note: There are risks involved when applying for a loan. Consult the lender’s terms and conditions page for more information.