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Sometimes referred to as a second mortgage, home equity loans are one of the most common forms of home financing.  These loans allow borrowers who have paid down a significant portion of their mortgage to access their home equity in exchange for a lump sum cash payment with a fixed interest rate.  The homeowner pays the loan amount back to the lender over time in monthly installments that include accrued interest.

When a lender reviews your application for a home equity loan, they’ll review your financial profile to make sure you have the documented ability to repay your loan.  If you are not a W2 employee and have a non-traditional income source, you may have to provide additional documentation to prove to the lender that you have the ability to make your monthly payments over the term of the loan, typically 30 years.  

While the minimum credit score is lower for home equity loans than some other forms of financing, the higher your credit score, the more likely it is that you’ll qualify for the best rates.

If you have steady income and a high credit score, a home equity loan is a great option to consider if you’re planning to use your financing to pay for large, one time expenses.  Home equity loans are secured loans – meaning the debt you have been issued is secured by your property – and will likely offer you lower interest rates as compared to an unsecured loan such as a credit card or a personal loan.   

Because of this lower interest rate, some homeowners also use home equity loans to consolidate their unsecured debt and lower their overall interest payments.  

Finally, if you’re using a home equity loan to pay for home improvements, you may be able to take a tax deduction for the amount of interest you’d pay over the length of your loan.

While home equity loans are a good option for borrowers with a spotless financial record, if you take out a second mortgage without a solid plan for how you’ll use the money and how you’ll budget for your monthly payments, you could find yourself in an untenable position later on.  Missing just three payments could cause your property to go into foreclosure.

Before taking out a home equity loan, it’s also worthwhile to calculate the impact your loan length will have on your overall costs over time.   Interest payments can add up quickly – especially when considering a 30 year loan – and some lenders may charge a prepayment penalty (anywhere from 0.1%-20% of the loan) if you someday have the ability to pay the loan back earlier than scheduled.  If you’re considering a home equity loan, it’s worth asking your lender what prepayment penalty they’d charge if you suddenly come into a windfall or are otherwise able to pay off your loan earlier than planned.