What is a home equity loan?
A home equity loan is a type of secured financing that allows you to borrow money against your home's equity.
If you're a homeowner, equity loans can be easier to qualify for than a personal loan because you're using your home as a way to reduce the risk of lending to you.
Your home is used as collateral, so if you get into difficulties repaying a loan, your mortgage lender takes the first charge over your property, and the loan lender takes the second. For this reason, you may see home equity loans referred to as ‘second-charge mortgages’.
It is important to understand that with a home equity loan, If you default on repayments, your home is at risk of repossession.
What does home equity mean?
The equity in your home is the difference between what you owe your mortgage provider and what your home is currently worth.
An easy way to understand home equity is to subtract the amount you owe from the value of your home. Here's an example:
- Your current house is valued at £300,000
- Your outstanding mortgage balance is £100,000
= Therefore the equity in your home is £200,000
Why release equity from your home?
Taking equity out of your house can be helpful for many reasons. You may choose to use a mortgage equity loan to:
- Build an extension or renovate
- Purchase a second home
- Invest in a buy to let property
- Consolidate expensive debts
- Boost a pension
How do home equity loans work?
You can release equity from your home in several ways, but all involve using your property as security for a loan.
One of the most popular ways to release equity in your home is to take a secured home equity loan.
Secured loans
This type of loan is also known as a homeowner loan or collateral loan and can be used to release equity from a mortgaged home or property.
The equity in your house is used as collateral, which means if you can’t make repayments on the loan, the equity in your property will be used to cover the debt.
A home equity loan works like a regular first mortgage in several ways and you'll need to go through a similar application process.
You'll be credit checked and asked to provide evidence of your income, outgoings and debts. You'll also need to get your property valued and have a land registry search performed, usually at your own expense.
You'll typically get a fixed interest rate lower than a personal loan, although the annual percentage rate (APR) you're offered will ultimately depend on your credit rating and financial circumstances.
Once your application is approved, you'll receive your loan in a lump sum.
How much money can you borrow on a home equity loan?
This depends on the amount of equity you have in your home.
For example, if your house is valued at £300,000, and your outstanding mortgage is £100,000 - the equity in your home is £200,000.
It's unlikely your home equity lender will offer to lend you all £200,000 but you might be able to borrow up to 85% of that amount if you have a good credit rating.
With a home equity loan in the UK, the minimum amount you can borrow is usually £10,000.
How long do you have to pay back a home equity loan?
Terms usually range between five and 30 years, depending on how much you want to borrow.
Like with any other loan, it can help to repay money you’ve borrowed as soon as possible, within the agreement terms. This is because some lenders charge a penalty for early repayment, known as early redemption fees.
Choose a term based on what you can afford to pay back each month, and check the small print before you sign the credit agreement to make sure you fully understand any early repayment fees.
How long does it take to get an equity loan?
When you apply for an equity loan on your house, whilst you may get a decision in principle within the hour, it could take around three weeks or more before you get the money in your account.
You cannot get a secured loan instantly because several financial and legal checks need to happen, such as property valuation, credit checks and legal searches.
Is it a good idea to take equity out of your house?
If your money is tied up in property but you need a large sum of money, a home equity loan can be a cost-effective and convenient way to access funds.
Releasing equity with a secured loan can be a good idea if you are asset-rich but don’t have money available for the things you want to do. For example, your house has been valued for much more than you bought it for, you have a small mortgage, and you need a lump sum for a property extension.
A home equity security loan is a good option if you are:
- Already on a good fixed deal and remortgaging would mean a worse interest rate or costly early redemption charges on your current mortgage.
- Unable to remortgage or set up an equity release scheme with a provider because of your age or income.
What are the advantages of a home equity loan?
There are pros and cons to choosing a home equity loan; here are some of the benefits:
- You can borrow large sums of money, depending on the amount of equity you have in your home
- Flexible repayment terms - your agreement could be long or short term, between five and 30 years
- It can be cheaper than remortgaging if you have to pay early redemption fees or switch from a good fixed rate
- If you're self-employed or retired, a secured loan could be easier to get as you pose less risk to the lender when you borrow against your property
- Bad credit is less of an obstacle because your home as collateral reduces the lending risk that you may not repay the loan
What is the downside of a home equity loan?
Despite the advantages, there are also some things to consider before applying for a home equity loan:
- If you default on repayments, your home is at risk of repossession
- Set up costs and legal fees could hike the cost of the loan considerably
- You may have to pay early exit penalties if you decide to settle your loan early
What are the alternatives to a home equity loan?
If you have equity in your home and need cash, there are several other ways to release funds.
Remortgaging
Remortgaging involves switching your existing mortgage to a new deal and releasing funds. You can remortgage with the same mortgage provider or with a completely different lender.
Just like with a secured loan, your new mortgage is secured against your home or existing property.
Bear in mind, when you increase your mortgage, your monthly payments are likely to go up, although, if you're young, you may be able to extend the mortgage term instead to spread the cost of the loan over a longer period.
Equity release schemes
This scheme allows people aged 55 and over to release tax-free money from their home without making any monthly repayments.
There are two types of equity release:
- Lifetime Mortgages - a loan with rolled-up interest
- Home Reversion plans - a provider purchases all or part of you home
If you are an eligible homeowner, you can draw a single lump sum or draw down a regular, smaller sum from the proceeds while remaining in your home.
Instead of making monthly repayments, the interest accrued on your lifetime mortgage is added to the loan and rolled up. When you die or move into a care home, your house is sold and the equity release provider will take any outstanding debt from the sale proceeds.
Home equity loan FAQs
Whilst a home equity loan is a type of mortgage, this type of loan is taken out after buying a house and building equity. A mortgage allows you to borrow the money to purchase the property initially.
You can not get a home equity loan without a first mortgage.
Approval for a home equity loan takes into account more factors than an unsecured personal loan, meaning having a good credit rating is less important.
Secured loans tend to be easier to get and less dependent on your credit rating because you're providing equity in your home as collateral. To take out the minimum amount of equity loan, you would need at least £12,000 equity in your property.
That said, if you have bad credit or a very low credit score, the APR will be higher and you won't be offered the low rates advertised.
No, if you’re approved for a secured equity loan and make your repayments in full and on time, you could, in fact, boost your credit score.
If you have a bad credit score, rather than apply for a loan from multiple lenders (which could hurt your credit rating), you can use a comparison site like ours to find an equity release loan provider. Using our eligibility checker, we can help match you with loan providers that are most likely to lend to you, without hurting your credit score.
Any form of borrowing can be expensive because lenders add interest to the total cost of borrowing. Home equity loan interest rates depend on:
The equity in your property
The amount you borrow
The borrowing term
Your credit rating
In addition to the interest rate, home equity loans can come with high set-up costs and legal fees which will add to the overall cost of the loan, so it’s important to make sure you can afford the repayments before taking out the loan.