Home equity equals your home's value minus outstanding loans. A home equity loan gives a fixed lump sum and fixed payments. A HELOC provides a revolving credit line with a draw period and typically variable rates. Both are secured by your home, affect CLTV, and have specific tax rules for interest deductibility.
What is home equity?
Home equity is the portion of your property's value that you actually own: the market value of the home minus any outstanding mortgage balances. As you pay down the mortgage or as the home appreciates, your equity grows. Homeowners tap that equity when they need cash for renovations, debt consolidation, education, or other expenses.
Two common ways to borrow against equity
Home equity loan (second mortgage)
A home equity loan is a lump-sum loan secured by a second lien on your house. It normally carries a fixed interest rate and fixed monthly payments over a set term. Once you take the lump sum, you cannot re-borrow against the same loan - it functions like a conventional installment loan.
Home equity line of credit (HELOC)
A HELOC works like a revolving line of credit secured by your home. During a draw period (commonly 5-10 years), you can borrow, repay, and borrow again up to an approved limit. After the draw period ends, most HELOCs enter a repayment phase (often 10-20 years), when additional draws stop and you must repay principal and interest.
HELOC interest rates are usually variable and tied to an index such as the prime rate, though some lenders offer fixed-rate options for portions of the balance.
Why lenders limit borrowing
Lenders evaluate combined loan-to-value (CLTV) - the total of your first mortgage plus any second mortgage divided by the home's value - to set lending limits. Many lenders commonly cap CLTV in the 80-90% range, though exact limits vary by lender, loan type and borrower credit profile.
Costs, risks and tax treatment
Both home equity loans and HELOCs use your house as collateral. If you default, the lender can foreclose. Interest rates, fees, and payment terms differ by product and market conditions; borrowing costs rose after the low-rate environment of 2020-2021, making timing and rate structure important considerations.
Under current U.S. tax rules, interest on home equity borrowing may be tax-deductible only when the funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan. Consult a tax professional about how the rules apply to your situation.
When to consider each option
Choose a home equity loan when you need a fixed amount for a defined project and prefer predictable payments. Choose a HELOC when you want flexible access to funds over time, but be prepared for variable payments and the risk of higher rates. A cash-out refinance is an alternative if you want to replace your first mortgage and the second mortgage with a single loan.
Practical next steps
Check current rates and CLTV policies at multiple lenders, compare fees and repayment terms, and ask how a HELOC's draw and repayment periods work. If you're unsure about tax consequences or the impact on your long-term mortgage plan, speak with a tax advisor or mortgage professional.