What Is a Home Equity Loan and How Does It Work?

Owning a home can be about more than having a place to call your own. As you make mortgage payments and your home’s value changes over time, you may also be building something valuable: home equity.

That equity can sometimes be used to help pay for larger expenses, from remodeling your kitchen to consolidating debt or covering another major financial need. One way homeowners can access it is through a home equity loan.

But what exactly is a home equity loan? How does it work? And when might it make sense to consider one?

Let’s break it down.

First, What Is Home Equity?
Home equity is the difference between what your home is currently worth and how much you still owe on your mortgage.

For example, if your home is worth $250,000 and you owe $150,000 on your mortgage, you have approximately $100,000 in equity.

Equity can grow in a couple of ways. As you make mortgage payments, you gradually reduce the amount you owe. Your equity may also increase if the value of your home rises over time.

That doesn’t mean all of that equity is necessarily available to borrow, but it can give you a financial resource to explore when you need funds for a larger expense.

So, What Is a Home Equity Loan?
A home equity loan allows you to borrow money using the equity you’ve built in your home as collateral.

Unlike some forms of borrowing that provide access to money as you need it, a home equity loan typically provides the approved amount as a lump sum. You then repay that amount over an agreed-upon period through regular monthly payments.

Because the loan is secured by your home, it’s important to treat the decision carefully and make sure the payment comfortably fits within your budget.

How Does a Home Equity Loan Work?
The process starts by determining how much equity you have in your home and how much you may be eligible to borrow.

When you apply, the lender will generally consider several factors, including your home’s value, how much you still owe on it, your credit history, income, existing debts, and overall ability to repay the loan.

If you're approved, you'll receive the loan proceeds and begin making payments according to the terms of your loan.

The exact amount you can borrow, your interest rate, repayment period, and monthly payment will depend on your individual financial situation and the lender's requirements.

What Can You Use a Home Equity Loan For?
One advantage of a home equity loan is its flexibility. Homeowners may consider using one for a variety of larger expenses.

Common uses include:

• Home renovations or repairs
• Kitchen or bathroom updates
• A new roof, windows, or other major home projects
• Debt consolidation
• Education expenses
• Major unexpected expenses
• Other significant purchases or financial needs

Home improvements are a particularly common use because you're using the equity you've built in your home to invest back into the property.

That said, just because you can use home equity for something doesn't necessarily mean you should. Before borrowing, consider whether the expense is worth taking on additional debt and how the new payment will fit into your overall financial picture.

Home Equity Loan vs. HELOC: What’s the Difference?
You may also hear about a Home Equity Line of Credit, or HELOC, when researching ways to access your home equity.

While both use your home's equity, they work differently.

A home equity loan generally gives you a lump sum upfront that you repay over a set period. A HELOC works more like a revolving line of credit, allowing you to borrow as needed up to an approved limit during a specified period.

Which option makes sense can depend on how you plan to use the money. If you know how much you need for a specific project or expense, a home equity loan may provide the predictability you're looking for. If your expenses will happen over time or you're unsure exactly how much you'll need, you may want to learn more about how a HELOC works.

What Should You Consider Before Borrowing?
Your home equity can be a useful financial resource, but borrowing against it is still a significant decision.

Before applying, ask yourself a few questions:

How much do I actually need?
Start with the expense itself rather than automatically borrowing the maximum amount available to you.

Can the monthly payment comfortably fit into my budget?
Look at your current expenses and consider how another loan payment would affect your finances each month.

What will the money be used for?
Consider whether taking on debt makes sense for the expense you're planning.

What will the loan cost overall?
Look beyond the amount you're borrowing. Your interest rate, loan term, fees, and other costs can all affect what you ultimately pay.

And don't be afraid to ask questions. Understanding the details before signing anything can help you make a more informed decision.

Is a Home Equity Loan Right for You?
There isn't one answer that works for every homeowner.

A home equity loan may be worth exploring if you've built equity in your home, have a specific expense in mind, and are comfortable adding another payment to your budget.

For someone planning a major home renovation, for example, having a lump sum available may make it easier to establish a project budget. For someone with a smaller expense that can be covered comfortably with savings, borrowing against a home may not be necessary.

The important part is understanding your options and choosing the one that makes sense for your financial situation.

Put Your Home Equity to Work for What’s Next
The equity you've built in your home didn't happen overnight. It grew along with every mortgage payment, every improvement, and every year of homeownership.

When the time comes for a major project or expense, that equity may give you another financing option to consider.

At Lakeshore Federal Credit Union, we're here to help you understand how a home equity loan works, explore your options, and determine what fits your goals and budget.

Whether you're ready to tackle the project that's been sitting on your list or simply want to understand what's available to you, our team is here to help you take the next step.

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