A home equity loan (HEL) is a loan taken against the equity in a house for a maximum amount and a fixed period of time. The maximum amount is usually equal to the equity available in the home. This maximum amount is governed by state law. The amount borrowed is usually taken as a lump sum and it becomes a second mortgage against the home. The interest rate on a HEL is usually fixed and the payments are calculated just like a regular fixed rate mortgage.
A HEL can be taken for any length of time but 15 years is common. Many people take out home equity loans to finance renovations, college education or some other large expense.
Determining Principal and Interest Payment
The first step in calculating HEL payments is to determine the principal. The principal on the HEL is the amount you borrowed. This will usually not exceed the equity in your home.
Next compute the first interest payment. The interest is usually fixed as agreed upon when you apply for the loan. For example if you borrowed $50,000 at a 5 percent interest rate, the monthly interest payment for the first month is $208.33, based on the formula: (5% x $50,000)/12; the monthly interest rate is 5 percent divided by 12.
Calculating the Monthly Payment
Calculate the monthly payment by using a financial calculator such as BAII Plus from Texas Instruments, the FC-200V from Casio or the HP 12c from Hewlett Packard. Follow the instructions on the calculator to compute the monthly payment. In this example the monthly payment is $395.40.
The next step is to compute the monthly principal payment. The monthly payment is a combination of the principal payment and the interest payment. As the loan matures and the principal goes down, you pay more in principal and less in interest. Thus:
- Monthly Interest Payment = Principal Balance x Monthly Interest Rate
- Monthly Principal Payment = Monthly Payment - Monthly Interest Payment
Creating the Amortization Schedule
Finally, create an amortization schedule using the previous formulas. An amortization schedule is simply a table showing the breakdown of payments by interest and principal and how much of the principal balance is left. Eventually the principal balance becomes zero and the loan is paid off.
In this case, a 15 year loan will result in a total of 180 monthly payments. Although each monthly payment is fixed, the payment toward principal will gradually increase and the payment toward interest will gradually decrease.
Using an Online Calculator
The easiest way to calculate your home equity loan payments is to use an online calculator. Some of these calculators will not only calculate your monthly payment but can also create an amortization schedule. You can find these calculators on banking websites for companies such as Citi, Bank of America and US Bank and on financial websites such as NerdWallet and Bankrate.