Important Things You Should Know About Home Equity Loans
Home equity loans offer a way to borrow money to purchase big-ticket times. It is critical to understand the facts about these loans to ensure that you make the best financial decisions.
If you are thinking about taking a home equity loan out, first you should know about the 13 things below.
1. What Is a Home Equity Loan? (HEL)
This type of loan is where a borrower uses the equity in their home as collateral on the loan. Home equity loans let you borrow a large lump sum of money based on your home’s value, determined by a professional appraiser, and the current equity in your property.
There are both adjustable-rate and fixed-rate home equity loans that are available and they also have different amounts of time for repaying the debt, and typically range from 5 to 30 years. There are also closing costs that must be paid, but they are much less than the ones paid on a full mortgage.
Fixed-rate home equity loans offer the predictability of a fixed interest rate from the very beginning, which is preferred by some borrowers.
2. What Are The Best Uses For A Home Equity Loans?
Usually, home equity loans are best used for individuals who need money to pay for a major expense, such as a home renovation project. One thing that home equity loans are not especially useful for is to borrow small sums of money.
Typically lenders don’t want to deal with making small home equity loans. About the smallest amount that you can get is $10,000. For example, Bank of America has a minimum of $25,000 for its home equity loan amount, while Discover offers $35,000 to $150,000 home equity loans.
3. What Is a Home Equity Line of Credit? (HELOC)
This is a revolving line of credit that is based on your home’s equity. After the limit has been set by the lender, you will be able to draw on the line of credit whenever you want to over the life of your loan by simply writing a check against this line of credit.
A HELOC in some ways is similar to credit cards: you don’t have to borrow the entire amount of the loan, and your available credit gets replenished as you continue to pay it back. You could, in fact, pay the loan back in full over the draw period, then re-borrow the total line of credit amount, and then repay it once again.
Typically the draw period will last around ten years with a repayment period of 10 to 20 years. You only pay interest on the amount you borrow from the total amount that is available, and usually, you are not required to repay the loan until the draw period closes.
Sometimes HELOC loans also have an annual fee. The repayment period for a HELOC has adjustable interest rates, and usually, they are based on the prime rate, although often they can be converted over to a fix-rate loan following a certain time period. Also, there are usually closing costs that need to be repaid on a loan.
4. What Is A Home Equity Line Of Credit The Best For?
A HELOC is usually best for individuals who are expecting to need a varying amount of money over time. For instance, to get a business started. If you do not need as much as is required by a home equity loan, you can choose a HELOC instead, and borrow only what you actually need.
5. What Are the Benefits of Home Equity Lines of Credit and Home Equity Loans?
Beyond having access to large amounts of money, home equity lines of credit and home equity loans also have the advantage is usually the interest that you pay is tax-deductible for people who itemize deductions, since it is same as conventional mortgage interest.
Federal tax law lets you deduct mortgage interest on home equity debt of up to $100,000 ($50,00 each for married people who file separately). However, there are some limitations, so consult with your tax adviser in order to determine what your eligibility is.
Because home equity line of credit and home equity loans are secured by your house, the interest rates tend to be lower as well compared to what you would pay on an unsecured loan or credit card.
6. What Are the Main Disadvantages of Home Equity Lines of Credit and Home Equity Loans?
The debt that you are taking on from a HELOC or HEL is secured by your house, which means that your property is the collateral on the loan and may be at risk if you do not make all of your loan payments. You could potentially be foreclosed on your home and lose if you are delinquent on your home equity loan, and also the same thing is true on your main mortgage.
In the event of a foreclosure, the first to be paid off is the primary mortgage lender, then the home equity lender gets paid with whatever is remaining.
If the value of your home declines, you might go underwater and end up owing more money than your home is worth. Rates on HELOCs and HELs also have a tendency to be higher than what you would pay currently on a mortgage and then fees and closing costs can start to add up.
7. Can I Determine What My Equity Is?
If you have an interest in learning how you can qualify to get a home equity loan, the first thing that needs to be determined is the amount of equity you have in your home.
Equity is the part of your house that you own, while that part that you owe is owned by the bank. If your house has a $250,000 value and you owe $200,000 still on your mortgage, and the equity that you have is $50,000, or 20%.
This information is commonly referred to as the loan-to-value ratio – which is the balance that is remaining on your loan that is compared to the value of your property – and in this case, it is 80% ($200,000 is 80% of $250,000).
8. How Can I Qualify To Get a Home Equity Loan?
In general, lenders will usually require you to have an 80% loan-to-value ratio at least that remains after a home equity loan to be approved. This means you will need to own over 20% of your home before being able to qualify to get a home equity loan.
If you own a $250,000 house, you need 30% equity at least – a mortgage loan balance of a maximum of $175,000 – to qualify to get a home equity line of credit or equity loan of $25,000.
9. If I Have Bad Credit Can I Still Get A Home Equity Loan?
Many lenders require a good or excellent credit rating in order to qualify to get a home equity loan. To get a home equity loan it is recommended to have a credit score of at least 620 and to get a home equity line of credit you might need to have an even higher score than that.
However, there are some situations where someone with bad credit might still be able to get a home equity loan if they have a low debt-to-income ratio and have a high amount of equity in their house.
If you believe you will be shopping for a home equity line of credit or home equity loan fairly soon, you should first consider taking the steps to improve your credit.
10. How Soon Will I Be Able To Get A Home Equity Loan?
You can technically get a home equity loan right after you buy a house. However, home equity usually builds up slowly, and that means it may be a while before you have built up enough equity in order to qualify for a home equity loan.
It may take five to seven years to start to pay down on the principal of your mortgage and start to build equity.
The normal processing time for a home equity loan can be anywhere from two to four weeks.
11. Is It Possible To Have More Than One Home Equity Lines of Credit?
It is possible to have more than one home equity lines of credit, but it is rare, and not many lenders offer multiple ones. You would need to have excellent credit and substantial equity in order to qualify for multiple home equity lines of credit or loan.
If you apply for two HELOCs at once but from two different lenders but do not disclose them it is considered to be mortgage fraud.
12. How Are The Best Banks To Get Home Equity Loans From?
Brokers, mortgage lenders, credit unions, and banks all provide home equity loans. A little shopping around and research will help you determine which of the banks are offering the best interest rates and home equity products for your situation.
Start with the credit unions and banks where you have a relationship already, but also ask for referrals from family and friends who have received loans recently and also make sure that you ask about fees. Insight can also be provided by real estate agents.
If you are not sure of where to get started, the following are a couple of options for you to consider:
- -Lending Tree works along with qualified partners in order to the best interest rates and provides an easy way of comparing lending options.
- -Discover provides home equity loans range from $35,000 up to $150,000 and they make it very easy to apply for loans online. At closing, there is no cash required or application fees.
- -Bank of America on primary homes provides HELOCs of up to $1,000,000, makes it very easy to apply for online, and for existing bank customers offers fee reductions, but does have higher debt-to-income ratio requirements to many other lenders.
- – Citibank has options for applying in person, over the phone, or online for both HELOCs and HELs. Citibank will also waive closing costs and application fees – but on HELOCS there is an annual fee that they charge.
- – Wells Fargo currently only offers HELOCs with fixed rates, but discounts are offered to Wells Fargo customers, and reduce interest rates if the closing costs are covered.
13. How to Apply for a Home Equity Loan
Before you are able to apply for a home equity loan there are certain requirements that must b met. Follow the five steps below to improve your chances of getting approved for a home equity loan:
- – Check your credit score. Having a good credit score makes it easier to qualify for a home equity loan. Before you apply for a loan, review your credit report first. If your credit score is less than 620, and you aren’t desperate to get a loan, you might want to take the necessary step to improve your credit before applying.
- – Determine what your available equity is. The amount of your equity will determine how large of a loan you are able to qualify for. You can get a general sense of the amount of equity that your house has by checking websites like Zillow in order to determine what its current value is and then deducting the amount that you owe still. The lending institution’s appraiser will determine what the official value of your house is (and therefore what your equity is) when you apply for the loan, but you can get a pretty good sense of the amount of equity you might have by doing a bit of research first.
- – Check your Debt – YOur likelihood of qualifying for a home equity loan will also be determined by your debt-to-income ratio. If you have lots of debt, you might want to work at paying it down first before applying to get a home equity loan.
- – Research rates at various lending institutions and banks. NOt every lending institution and bank will require the same qualifications, fees, or rates on their loans. Do your search and before you start the application process, review multiple lenders.
- – Collect the required information. It may be a lengthy process to apply for a home equity line of credit or home equity loan. You can speed up things by collecting the necessary information before you get started. Depending on the lending institution you work with, you might have to provide tax returns, pay stubs, a deed and more.
If you need to have a loan to help with covering your upcoming expense, be sure that you are prepared. Check our Loan Learning Center to review more resources on different kinds of loans that are available.
FAQs on Home Equity Loan
The following are a couple of the more commonly asked questions on home equity lines of credit or home equity loans:
- Why is a home equity loan a good option for financing?
- Usually, home equity loans come with a lower interest rate compared to another form of credit or traditional loan. Also, it is a secured loan and your house is the collateral. Therefore, the bank views the loan as less risky. Also, as previously mentioned, it is a tax-deductible form of financing.
- Variable or Fixed Interest Rate?
- Home equity loans have a fixed interest rate since it is considered to be an installment loan. But a home equity line of credit might have an interest rate.
Why does a home equity loan have closing costs?
Closing costs are necessary to set a home equity line of credit or home equity loan. These closing costs may cover the property appraisal fee for finding the value of the house, title and property insurance, mortgage filing and preparation fees, a title search on the property, attorney’s fees, and application fee. Overall, fees might total up to two to five percent of the total amount of your loan.