Does a Home Equity Loan Raise Your Mortgage Payment?

A home equity loan generally does not alter the payment schedule or terms of your current mortgage. It functions as a separate financial obligation, adding another layer to a homeowner’s financial commitments.

How Home Equity Loans Work

A home equity loan allows a homeowner to borrow a lump sum of money, utilizing the equity built in their property as collateral. This type of financing is often referred to as a “second mortgage” or “junior lien” because it establishes a claim on the home that is subordinate to the primary mortgage.

The home’s equity, which is the difference between its current market value and the outstanding mortgage balance, serves as the basis for the loan amount. Lenders typically allow borrowing up to a certain percentage of the home’s combined loan-to-value (CLTV), often ranging from 80% to 90% of the appraised value. This means the total of all loans secured by the home, including the first mortgage and the new home equity loan, usually cannot exceed this percentage. The loan funds are disbursed in a single payment, providing immediate access to capital.

Calculating Your Home Equity Loan Payment

A home equity loan introduces a new, separate monthly payment obligation. This new payment is determined by several factors: the total loan amount, the interest rate, and the repayment term. Home equity loans typically feature a fixed interest rate, ensuring that your monthly payment for this loan remains consistent throughout its duration.

The repayment terms for home equity loans range from 5 to 30 years. A shorter term results in higher monthly payments but can lead to less interest paid over the life of the loan. Conversely, a longer term reduces the monthly payment, though it may increase the total interest cost. Each payment on a home equity loan consists of both principal and interest, systematically reducing the loan balance over time.

Home equity loans also involve closing costs, which typically range from 2% to 6% of the loan amount. These costs can include appraisal fees, origination fees, and document preparation fees. Interest paid on a home equity loan may be tax-deductible if the funds are used to buy, build, or substantially improve the home securing the loan, up to a combined mortgage debt limit of $750,000 for married couples filing jointly. This tax benefit applies through 2025 under current IRS guidelines.

Home Equity Loans Versus Other Options

A home equity loan maintains your existing first mortgage while adding a second, distinct payment. This contrasts with a cash-out refinance, which replaces your original mortgage with an entirely new, larger loan. A cash-out refinance typically involves a new interest rate and repayment term for the entire, consolidated loan amount, thereby changing and often increasing your monthly mortgage payment. This option can be suitable if current interest rates are significantly lower than your original mortgage rate, or if you prefer to have a single mortgage payment.

Another option is a Home Equity Line of Credit (HELOC), which functions as a revolving credit line. With a HELOC, you can draw funds as needed up to an approved limit, and payments during the draw period might be interest-only. Unlike home equity loans which usually have fixed interest rates, HELOCs typically have variable interest rates, meaning monthly payments can fluctuate based on market conditions.

Managing Your Combined Housing Costs

Taking on a home equity loan means you will have two distinct housing-related payments each month: your original mortgage payment and the new home equity loan payment. This increased total monthly obligation necessitates careful budgeting and financial planning. Understanding your household’s overall financial capacity to comfortably manage both payments is important.

The combined payments also affect your debt-to-income (DTI) ratio, which lenders assess to determine your ability to manage additional debt. A higher DTI ratio could impact your eligibility for other credit in the future. It is prudent to ensure that the total monthly housing expenses remain manageable within your income and other financial commitments, preventing financial strain. Thoughtful consideration of your financial situation helps ensure responsible borrowing.