If you’ve owned a home for a while now, you know it’s more than a piece of the “American Dream”. It can also be the most valuable asset you own, an asset you can tap into when you need to borrow money, whether through a home equity loan or through a home equity loan. ” a home equity line of credit (HELOC). Here’s what you need to know to apply.
Key points to remember
- Home equity loans and home equity lines of credit are both based on the difference between the current value of your home and the amount you still owe on your mortgage.
- Home equity loans tend to have lower interest rates than other borrowing options because they are secured by your home and considered less risky for lenders.
- A home equity line of credit works like a credit card, in that you have a fixed credit limit that you can borrow when you need it, and then pay it back over time.
Home equity loans vs HELOCs
When it comes to borrowing money, a home equity loan and HELOC are backed by the most important collateral you can give: your home. As long as you have the equity in your home, which is the difference between the amount you currently owe on your mortgage and your home’s current market value, you can tap into a home equity loan or HELOC for part. of that net worth. Here’s how the two differ:
What is a home equity loan?
Home equity loans work much like other types of loans. Once approved by a lender, the borrower receives the entire loan in the form of a single lump sum. The money can be used as the borrower sees fit, such as for debt consolidation, emergency bill payments, or a home improvement project. The borrower must then repay the loan through a series of scheduled payments. The term of a home equity loan can be anywhere from five to 30 years.
Home equity loans have a fixed interest rate. This rate will usually be lower than what the borrower might get on other types of loans, because using the home as collateral makes the loan a safer bet for the lender.
Home equity loans are also commonly referred to as second mortgage loans or home equity installment loans.
What is a Home Equity Line of Credit (HELOC)?
If home equity loans work like a traditional loan, then a home equity line of credit works the same as a secured credit card, except that instead of cash in the bank serving as collateral, the home of the borrower does so.
Once approved, the borrower can withdraw money through a revolving line of credit. As such, the owner can borrow a portion of their current credit limit, use the funds, pay those funds back with interest, and then withdraw more money later. This allows the owner to access cash when they need it rather than all at once. This could be useful, for example, if you plan to remodel your kitchen this year and add a patio in a year or two.
Unlike a home equity loan, but similar to most credit cards, HELOCs have a variable interest rate. The rate will fluctuate over time depending on market forces, the borrower’s credit rating and the amount they are borrowing at any given time. This results in a minimum payment that can increase or decrease between scheduled payments, making HELOCs less predictable to the borrower than a home equity loan.
Requirements for Applying for a Home Equity Loan or HELOC
If you know exactly how much you need to borrow and can repay that amount over several years, then a home equity loan is probably the right choice for you. However, if you’re not sure how much you’ll actually need to borrow or how long you’ll need to keep withdrawing money, you should consider a HELOC instead.
Once you’ve made this decision and want to move forward, there are some rules that you will need to follow before a lender will approve you. Typically, both options have similar requirements, although each lender is different and may require something that their competition does not. Laws may also differ from state to state. Here are some of the requirements that you are likely to meet:
- You will need sufficient equity. First of all, of course, you will need to have equity to borrow. Keep in mind that lenders won’t let you borrow your full amount of equity, but will generally limit you to a maximum of 85%. So if you have accumulated $ 50,000 in equity, you could borrow up to $ 42,500 if you meet all the other conditions. Also note that home equity loans and lines of credit typically have closing costs of several thousand dollars, so you’ll walk away with less than the amount you borrowed.
- You will need a good credit rating. Potential lenders will also expect you to have a a strong credit score, which they use as an indicator of how risky you are giving a loan. Although lenders differ, most will want to see a credit score in the mid-600s or higher before even considering your application. Obviously, the higher your credit score, the better. (The highest possible credit score is 850, but anything above 670 is considered good.) The lender will also check your credit report for additional information regarding your creditworthiness, including the types of credit you have. have, how much you owe, how long these accounts have been open and if you have any overdue payments on your file.
- You can’t have too much other debt. The lender will also consider your debt-to-income ratio (DTI), which measures how much of your monthly income is already allocated to other outstanding debts. You will likely need to provide proof of income in the form of pay stubs, W-2 forms, or other relevant documents. In most cases, lenders will want to see a DTI of no more than 36%, although some may be as high as 43%. All of your monthly borrowing expenses, including your current mortgage payment, any student loan debt, your credit card bills, and other debts are added up and then divided by your monthly income to arrive at this number.
The bottom line
If you have equity in your home, a home equity loan or HELOC can be an easy way to harness some of that equity for other purposes. Which one is best for you basically depends on whether you need to borrow a fixed amount now or whether you prefer a more flexible line of credit that you can use as needed.
Keep in mind, of course, that a home equity loan or HELOC will put you in even more debt, which could be a problem if you suffer a serious financial setback due to job loss, major medical bills. or other unforeseen events. And because these loans are secured by your home, you could possibly lose it if you are not able to keep up with the payments.
How Much Equity Do I Need to Get a Home Equity Loan?
Most lenders will want you to have at least 15-20% of your home equity before and after the home equity loan. So, for example, if your house is currently worth $ 300,000 and you still owe $ 270,000 on your mortgage, your equity is $ 30,000, or 10%. In this case, you probably wouldn’t qualify for a home equity loan or HELOC. If, however, you owed only $ 200,000 on your mortgage, you would have $ 100,000, or 33%, in equity and you would likely qualify for it.
How do I determine the equity in my home?
To determine the equity in your home, you will need two digits.
The first is the amount you still owe on your mortgage. This number may appear on your monthly mortgage statement or on the mortgage amortization schedule provided by your lender. Or, you can just call your lender and ask.
The second number is the current value of your home. You can get a rough estimate by asking a local real estate agent or checking what homes comparable to yours have sold for recently. For a more precise estimate, you can call on a professional real estate expert.
What are the alternatives to a home equity loan or line of credit?
If you are unable to secure a home equity loan or HELOC, you may be eligible for a personal loan from a bank or other lender. These loans tend to have higher interest rates than a home equity loan or HELOC, but, in the case of an unsecured personal loan, you will not be putting your home at risk.