Why the 20-year home equity loan works

Your home tells a story—one of dreams, memories, and potential. What if you could unlock its power to help you reach your most important financial goals? A 20-year home equity loan could help you transform your vision into reality and get you closer to your most ambitious objectives. A 20-year home equity loan could be a flexible, predictable, and smart way to borrow. 

Let's explore how this financial tool works, and how it could help you build the future you deserve.

How a 20-year home equity loan works 

Home equity loans are considered second mortgages because, like your first mortgage, your home is the collateral for the loan. Collateral is something of value that guarantees the loan. If you don’t repay the debt, you could lose the collateral. 

This helps explain why the interest rate for a home equity loan can be so attractive. When the lender offers you a loan, that means they trust you to make all the payments. But if you don’t, the home is their safety net. 

A 20-year repayment period is long enough that you could borrow a large amount of money to reach a big financial goal, but still have payments that you can afford. 

Loan structure 

Home equity loans usually have a fixed interest rate, meaning your monthly payment will never change. From day one, you’ll know to the penny how much your payment is and can plan for it in your budget.

And since you know exactly how much you’ll pay, you also know how much you owe. You can easily plug your loan into a budgeting app and track your progress. 

The 20-year home equity loan process 

Taking out a 20-year home equity loan is simple. Here’s what you can expect:

• You request pre-approval: This application doesn't dig too deep. It will ask you to provide basic information, like your name, address, Social Security number, and income. 

• The lender lets you know where you stand: Based on the information you provide, the lender determines whether you’re likely to qualify. Be sure the lender offers pre-approval with a soft credit check, so your credit score doesn’t get dinged.

• The lender verifies the current market value of the home: A home equity lender might use software or an in-person appraisal to determine how much your home is worth.

• The lender provides details: If the lender determines that you’d be a good candidate for a loan and you have sufficient home equity, they’ll let you know the amount you're qualified to borrow, what interest rate you’ll pay, and what fees are required.

• You decide if you want the loan: Once you’ve reviewed the loan terms, you tell the lender whether you’re still interested. If you are, the lender moves on to the next step: loan qualification.

• You submit a formal application: This is when you should expect a hard credit check that could temporarily cause your credit score to dip.

• The loan application goes to underwriting: The lender checks your income, credit standing, and financial situation. 

• You receive a loan contract: Once you receive word that your application has been approved, you're presented with a contract. Your last step is to sign the agreement and wait for the funds.

• Your loan is funded: Home equity loans come in a lump sum, meaning you’ll receive a check for the total amount borrowed.

• You begin making monthly payments: Your first payment is typically due in about 30 days.

What makes a 20-year home equity loan attractive? 

A typical home equity loan term ranges from five to 30 years. A 20-year term gives you the best of both worlds—it’s long enough to help keep your payments low but short enough to shine some light at the end of the tunnel.

Let’s say you’ve decided you want to remodel your forever home. You’re looking for a more comfortable living space and want to tackle some projects that could improve your quality of life, and maybe even add value to your home.

You want to borrow $85,000 to complete the remodel and a lender offers you an annual percentage rate (APR) of 12%. 

Here’s how much you could pay each month with different terms.  

This table is for informational purposes only. Interest rate and payments are for illustration only. Individual results vary. This example uses the Actual 360 interest calculation method. 

You’ve budgeted $1,000 per month for the payment, so the 20-year home equity loan looks like a good fit.

How much can you borrow with a 20-year home equity loan? 

Here’s how a lender decides what you can borrow:

Your financial situation

A lender checks your credit history and income because they want to learn whether a new loan will fit neatly into your budget or cause undue hardship. Lenders may review your employment history, bank accounts, and how well you've managed debt in the past. Each lender has its own criteria for loan approval.

The amount of home equity you have

Since you’re borrowing against the equity in your home, the lender needs to know how much equity exists. Your home equity is the difference between the current market value and the amount you owe on your mortgage. 

Lenders verify the property value by the method of their choosing. For a home equity loan, that method is typically valuation software, not an in-person appraisal.

Combined loan-to-value ratio (CLTV)

This is the amount you owe on the property compared to what it’s worth. It includes the primary mortgage and the new loan that you want. Lenders limit the CLTV. Typically, you can’t owe more than 80-100% of your home’s value. 

So if your current mortgage is equal to 50% of the home’s value, and your lender’s CLTV limit is 80%, your home equity loan amount would be limited to 30% of the home’s value.

Lender’s loan limit

Lenders have a dollar limit on each loan they make. Your loan can’t be above this number even if you can afford it and your CLTV is under the maximum.

Let’s look at an example, using our $85,000 renovation loan. 

In this example, you could apply for a $85,000 home equity loan.

Pros and cons of a 20-year home equity loan

Before entering into a home equity loan, it pays to understand the pros and cons. 

Pros

• Fixed monthly payment.

• Lower monthly payment than a shorter-term loan.

• Potentially lower interest rate than you could get with another kind of loan.

• Much lower interest rate than most credit cards. 

Cons

• Because it’s a secured loan, your home is collateral, meaning if you don’t repay the loan, you could lose your home. 

• If you repay the loan in full over 20 years, you'll pay more in interest than you would have if you had taken out a shorter-term loan.

• Some lenders charge a prepayment penalty if you want to pay off the loan early. (Better to go with a lender that doesn't charge a penalty.)

Is a 20-year home equity loan right for you?

Whether a 20-year home equity loan is right for you depends on its purpose, your long-term plans, and your readiness to take on new debt. Here are some of the reasons homeowners take out a loan:

• Debt consolidation

• Financing home improvements or upgrades

• Making repairs to your home or property

• Paying medical bills

Like any important life decision, consider the impact of a home equity loan on your budget. Before moving forward, you may want to ask yourself these questions:

• Do I have a specific use for the money?

• Have I figured out how much I need to borrow?

• How does my credit report look? Have I ordered a copy recently to ensure that it's mistake-free?

• Is there room in my monthly budget for a new debt?

• Do I have a financial plan if things go south and I Iose my job or become ill? 

Other benefits of 20-year home equity loans

One thing that makes a home equity loan so attractive is the fixed interest rate. For example, if you take out a loan with a 12% APR, it will remain 12% for all 20 years. You also know exactly:

• The amount of your monthly payments 

• When the loan will be paid off 

• How much interest you'll pay

Tax implications

You could get a tax break by taking out a home equity loan. Home equity loans are mortgages. The interest you pay on any mortgage may be tax deductible in 2024 and 2025, as long as you:

• Use the money to buy, build, or improve your home 

• Itemize your deductions at tax time

After 2025, the interest may be tax deductible, no matter how you use the loan proceeds. As part of your decision-making, you'll want to consult with a qualified tax professional to understand the tax implications fully. 

Impact of loan term 

One thing to keep in mind is how the loan term you choose impacts how much you'll ultimately pay for the loan. The table above shows how a longer term means a lower monthly payment.

However, a longer term increases overall interest costs. Compared to a 20-year term, if you pay off the loan in 10 years, you’ll pay less interest overall. If you pay off the loan in 30 years, you’ll pay more. Your mortgage consultant can help you compare different scenarios.

What's next

• Weigh your options. Will a home equity loan help you reach a financial milestone, such as renovations or debt consolidation? Does a new home equity loan payment fit in your budget?

• Calculate your needs. Thoroughly research the expenses you want to cover, so you can get a sense for how much you want to borrow. Consider making plans A, B, and C, at different dollar amounts, so you can adjust your expectations after the lender lets you know what you qualify for.

• Talk to a mortgage advisor. Share the details about your situation with a loan expert, to find out what the possible options might be.