What you need to know about home equity loans

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A USA TODAY motion graphic explaining the many acronyms that a home-buyer may encounter during the home buying and shopping process.  

RAMON PADILLA, FRANK POMPA, BERNA ELIBUYUK, CHARISSE JONES, MICHAEL STRUENING AND PHILANA PATTERSON

A home equity loan is a method for borrowing money for big-ticket items, and understanding the facts about these tricky loans is crucial to helping you make the right decision for your finances.

If you’re considering taking out a home equity loan, here are 13 things you need to know first.

https://www.usatoday.com/videos/money/personalfinance/2015/01/15/21825033/

If you’re considering taking out a home equity loan, here are 13 things you need to know first.  

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1. What is a home equity loan?

A home equity loan — or HEL — is a loan in which a borrower uses the equity of their house as collateral. These loans allow you to borrow a large lump sum amount based on the value of your home, which is determined by an appraiser, and your current equity.

Equity loans are available as either fixed- or adjustable-rate loans and come with a set amount of time to repay the debt, typically between 5 and 30 years. You’ll pay closing costs, but it’ll be much less than what you pay on a typical full mortgage. Fixed- rate HELs also offer the predictability of a regular interest rate from the start, which some borrowers prefer.

2. What are home equity loans best for?

A home equity loan is generally best for people who need cash to pay for a single major expense, like a specific home renovation project. Home equity loans are not particularly useful for borrowing small amounts of money.

Lenders typically don’t want to be bothered with making small loans — $10,000 is about the smallest you can get. Bank of America, for example, has a minimum home equity loan amount of $25,000, while Discover offers home equity loans in the range of $35,000 to $150,000.

3. What is a home equity line of credit?

A home equity line of credit — or HELOC — is a lender-set revolving credit line based on the equity of your home. Once the limit is set, you can draw on your line of credit at any time during the life of the loan by writing a check against it. A HELOC is similar to a credit card: you do not need to borrow the full amount of the loan, and the available credit is replenished as you pay it back. In fact, you could pay back the loan in full during the draw period, re-borrow the total amount, and pay it back again.

The draw period typically lasts about 10 years and the repayment period typically lasts between 10 and 20 years. You pay interest only on what you actually borrow from the available loan, and you usually don’t have to begin repaying the loan until after the draw period closes.

HELOC loans also sometimes come with annual fees. Interest rates on HELOCs are adjustable, and they are generally tied to the prime rate, although they can often be converted to a fixed rate after a certain period of time. You are also often required to pay closing costs on the loan.

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4. What are home equity lines of credit best for?

Home equity lines of credit are best for people who expect to need varying amounts of cash over time — for example, to start a business. If you don’t need to borrow as much as HELs require, you can opt for a HELOC and borrow only what you need instead.

5. What are the benefits of home equity loans and home equity lines of credit?

Beyond the access to large sums of money, another advantage of home equity loans and home equity lines of credit is that the interest you pay is usually tax-deductible for those who itemize deductions, the same as regular mortgage interest. Federal tax law allows you to deduct mortgage interest on up to $100,000 in home equity debt ($50,000 apiece for married persons filing separately). There are certain limitations, though, so check with a tax adviser to determine your own eligibility.

Because HELs and HELOCs are secured by your home, the rates also tend to be lower than you’d pay on credit cards or other unsecured loans.

6. What are the disadvantages of home equity loans and home equity lines of credit?

The debt you take on from a HEL or HELOC is secured by your home, meaning your property could be at risk if you fail to make the payments on your loans. You can be foreclosed on and lose your home if you’re delinquent on a home equity loan, the same as on your primary mortgage. In the case of a foreclosure, the primary mortgage lender is paid off first, and then the home equity lender is paid off out of whatever is left.

If your home’s value declines, you may go underwater and owe more than the house is worth. The rates for HELs and HELOCs also tend to be somewhat higher than what you’d currently pay for a full mortgage, and closing costs and other fees can add up.

7. How do I determine my equity?

If you’re interested in learning how to qualify for a home equity loan, first you need to determine how much equity you have.

Equity is the share of your home that you actually own, versus that which you still owe to the bank. If your home is valued at $250,000 and you still owe $200,000 on your mortgage, you have $50,000 in equity, or 20%.

The same information is more commonly described in terms of a loan-to-value ratio — that is, the remaining balance on your loan compared to the value of the property — which in this case would be 80% ($200,000 being 80% of $250,000).

Real Estate is constantly rising a safe investment. If you’re considering taking out a home equity loan, here are 13 things you need to know … Show more 

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8. How do I qualify for a home equity loan?

Generally speaking, lenders will require you to have at least an 80% loan-to-value ratio remaining after the home equity loan in order to be be approved. That means you’ll need to own more than 20% of your home before you can even qualify for a home equity loan.

If you have a $250,000 home, you’d need at least 30% equity — a mortgage loan balance of no more than $175,000 — in order to qualify for a $25,000 home equity loan or line of credit.

9. Can I get a home equity loan with bad credit?

Many lenders require good to excellent credit ratings to qualify for home equity loans. A score of 620 or higher is recommended for a home equity loan, and you may need an even higher score to qualify for a home equity line of credit. There are, however, certain situations where home equity loans may still be available to those with poor credit if they have considerable equity in their home and a low debt-to-income ratio.

If you think you’ll be in the market for a home equity loan or line of credit in the near future, consider taking steps to improve your credit score first.

10. How soon can I get a home equity loan?

Technically, you can get a home equity loan as soon as you purchase a home. However, home equity builds slowly, which means it can take a while before you have enough equity to qualify for a loan. In fact, it can take five to seven years to begin paying down the principal on your mortgage and start building equity.

The normal processing time for a home equity loan can be anywhere from two to four weeks.

11. Can I have multiple home equity lines of credit?

Although it is possible to have multiple home equity lines of credit, it is rare and few lenders will offer them. You would need substantial equity and excellent credit to qualify for multiple loans or lines of credit.

Applying for two HELOCs at the same time but from different lenders without disclosing them is considered mortgage fraud.

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Despite low mortgage rates, an improving labor market and elevated stock prices, consumers are still a bit cautious when it comes to buying a home.  

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12. What are the best banks for home equity loans?

Banks, credit unions, mortgage lenders, and brokers all offer home equity loan products. A little research and some shopping around will helpyou determine which banks offer the best home equity products and interest rates for your situation.

Start with the banks where you already have a working relationship, but also ask around for referrals from friends and family who have recently gotten loans, and be sure to ask about any fees. Experienced real estate agents can also provide some insight into this process.

If you’re unsure of where to start, here are a few options to review:

Lending Tree works with qualified partners to find the best rates and offers an easy way to compare lending options.

Discover offers home equity loans between $35,000 and $150,000 and makes it easy to apply online. There are no application fees or cash required at closing.

Bank of America offers HELOCs for up to $1,000,000 on a primary home, makes it easy to apply online, and offers fee reductions for existing bank customers, but it has higher debt-to-income ratio requirements than many other lenders.

Citibank allows you to apply online, over the phone, and in person for both HELs and HELOCs. It also waives application fees and closing costs—but it does charge an annual fee on HELOCs.

Wells Fargo currently offers only HELOCs with fixed rates, but the bank offers discounts for Wells Fargo accountholders, as well as reduced interest rates if you cover the closing costs.

13. How to apply for a home equity loan

There are certain home equity loan requirements you must meet before you can apply for a loan. For better chances of being approved for a loan, follow these five steps:

Check your current credit score. A good credit score will make it easier to qualify for a loan. Review your credit report before you apply. If your score is below 620 and you’re not desperate for a loan right now, you may want to take steps to improve your credit score before you apply.

Determine your available equity. Your equity determines how big of a loan you can qualify for. Get a sense of how much equity your home has by checking sites like Zillow to determine its current value and deducting how much you still owe. An appraiser from the lending institution will determine the official value (and therefore your equity) when you apply, but you can get a good sense of how much equity you may have by doing a little personal research first.

Check your debt. Your debt-to-income ratio will also determine your likelihood of qualification for a home equity loan. If you have a lot of debt, you may want to work on paying it down before you apply for a home equity loan.

Research rates at different banks and lending institutions. Not all banks and lending institutions require the same rates, fees, or qualifications for loans. Do your research and review multiple lenders before starting the application process.

Gather the required information. Applying for a home equity loan or line of credit can be a lengthy process. You can speed things up by gathering the necessary information before you begin. Depending on which lending institution you are working with, you may need to provide a deed, pay stubs, tax returns, and more.

If you need a loan to help cover upcoming expenses, make sure you’re prepared. Check out our Loan Learning Center for more resources on the different types of loans available.

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Note: It’s important to remember that interest rates, fees, and terms for credit cards, loans, and other financial products frequently change. As a result, rates, fees, and terms for credit cards, loans, and other financial products cited in these articles may have changed since the date of publication. Please be sure to verify current rates, fees, and terms with credit card issuers, banks, or other financial institutions directly.

More from Credit.com

Understanding Home Equity Lines of Credit

The Credit Approval Process & What to Expect

This article originally appeared on Credit.com.

Kirk Haverkamp is chief staff writer and editor for MortgageLoan.com. He covers the mortgage and personal finance industry from both a consumer and industry perspective, and provides guidance for consumers on how to approach the sometimes intimidating  process of obtaining the right mortgage and personal finance products for their needs.

How to Get a Small Business Loan

Small business loans fall into one of two types –– asset-based and factoring financing. Each loan requires different documentation and has different requirements, allowing you to choose the one that works best to keep your business going.

Decide on Loan Type

Asset-based loans are similar to traditional loans and require extensive documentation to show both that you are personally credit-worthy and that your business can keep up with the payment plan. Many financial institutions use the Small Business Administration’s 7(a) Loan Program to guarantee asset-based loan so there’s less risk to the lender.

If you just need short-term funding, consider a factoring loan, sometimes referred to as accounts receivable financing to cover a cash shortage. Factoring involves selling your accounts receivables to get a short-term loan. You'll get less than the balances owed, with the specific amount dependent on your industry and the perceived risk that any of the debts will go unpaid.

Qualifications

Qualifying for an asset-based loan generally requires a credit score that’s in the 700 to 800 range and up, according to Forbes. You may still qualify with a score in the 650-700 range. If you’ve been in business for at least a couple of years and can show a strong history of sales as well as reliable cash flow, you’re more likely to get the loan than a startup. You’re also more likely to get a loan if you have collateral with which to secure the loan, such as equity in real estate or an investment portfolio.

The bank requires fewer qualifications for a factoring loan. As long as you’ve set up your business properly and have a history of positive cash flow, you likely qualify.

Documentation Required

Develop a full business plan for asset-based loans. The plan explains your company’s strengths, weaknesses, opportunities and threats, also known as a SWOT analysis. Describe how your background and education help you run the business. Add financial data, including profit and loss statements for the past three years, if available. Include cash flow statements, a current balance sheet and three years of personal tax returns. Use the executive summary of your business plan to explain why you need the money and to tell your company’s unique story so the lender understands where your business is headed.

For factoring loans, you need an accounts receivables report that shows invoices for the past 90 days. Plan to complete an invoice factoring application and include business documentation that shows your company is set up with the proper government agencies, such as state and federal tax authorities.

Poor Credit Issues

Without a strong credit rating, your chances of getting an asset-based loan are greatly diminished. The SBA recommends providing additional documentation as part of your business plan if your credit score is weak or you have experienced bankruptcy. For instance, include bank deposits that show you make regular ongoing deposits and have positive cash flow. Another option is to find a credit partner who has a preferable credit score who is willing to co-sign for the loan.

Advantages & Disadvantages of Commercial Banking for Businesses

Running a small business is a time-consuming process. In addition to building the business and attracting and retaining customers, there is the added stress of finances. A business owner needs to plan to fund payroll, purchase products and pay taxes. A small business owner may look to a bank to help with some of these issues.

Commercial Banking
Commercial banking involves a division within a bank that focuses on business accounts and working with business owners. Some banks may refer to these services under the term "business banking" instead of commercial banking. The bank may offer services such as payroll processing, a way to pay your quarterly taxes, and financial planning services. The financial planning may also include the management of retirement accounts in addition to financial planning for the business. Many commercial banking divisions focus on lending money to help businesses stay afloat.

Advantages
Commercial banking can help a small business by making it easier to manage day-to-day financial tasks. An established commercial account with a bank will make it easier to borrow money when you grow your business. Often a business is assigned a representative who works directly with the company to find the best services and solutions for the issues the business is facing. For example, the company may save money by outsourcing payroll processing. Banks also offer invoicing services, with personalized invoices, and can set up transfers to other banks which will simplify accounting procedures. Some banks offer retirement account management for your employees as well as other employee benefits. This can save you money, and make it easier to manage all of the services you offer employees. Some banks allow you to make deposits online by scanning checks. Your bank may offer you discounts on your merchant services fees. Commercial banking allows you to set up direct deposits for your employees as well as for any invoices you need to pay to others, which will save you time.

Disadvantages
Commercial banking or business accounts are often more expensive than traditional bank accounts. Banks may charge fees for night deposits, for processing a certain number of checks and for the payroll services. Depending on the size of your business, some of the services offered may not be needed, and you may still be charged for the services even if you're not fully using them. Different banks may offer different services and charge different fees, and it can be difficult to compare the services. Signing up for a commercial account before your business is ready for one will cost you and may slow the growth of the business. If you choose the wrong bank, you may have a difficult time opening a new account and transferring all of the services to another bank. This can cost you both time and money.

Making the Choice for Your Business
As your business grows you may reach a point where you need commercial banking services. Visit several different banks to find out which services they offer, and the fees they charge. Look for a bank that features good customer service. Carefully examine any fees that it charges and see if the changes will be more beneficial or detrimental to your bottom line.

Home Equity Loans

If you have equity in your home – the house is worth more than you owe on it – you can use that equity to help pay for big projects. Home equity loans are good for renovating the house, consolidating credit card debt, paying off student loans and many other worthwhile projects.

Home equity loans and home equity lines of credit (HELOCs) use the borrower’s home as a source of collateral so interest rates are considerably lower than credit cards. The major difference between the two is that a home equity loan has a fixed interest rate and regular monthly payments are expected, while a HELOC has variable rates and offers a flexible payment schedule. Home equity loans and HELOCs are used for things like home renovations, credit card debt consolidation, major medical bills, education expenses and retirement income supplements. They must be repaid in full if the home is sold.

Home equity loans are closely related to home equity lines of credit (HELOCs), but there are subtle differences that make them distinct borrowing entities. Both home equity loans and home equity lines of credit use a consumer’s home as collateral based on the equity built up in the home. Additionally, both of these loan options have favorable interest rates when compared to other forms of borrowing and the interest can be written off on taxes.

Both typically are used to pay off things like home improvement projects, credit card debt, student loans and other forms of debt.

However, there are slight differences that make it important for consumers to examine both opportunities closely before deciding which is appropriate.

Home Equity Loans Act Like A Second Mortgage

A home equity loan gives the borrower a lump sum of money that is paid back over a fixed time and carries a fixed interest rate. In this way, it operates very much like a mortgage or auto loan.

How much you would be able to borrow is based on the amount of equity you have in your home. Equity is defined as the current value of the house minus how much is owed. So, for example, if your home is worth $150,000 and you owe $100,000, then you have $50,000 in home equity.

Most lenders offer 80 percent loan-to-value rates based on the amount of equity in your home. Using the example above, if you have $50,000 in home equity you would likely receive a loan of $40,000 ($50,000 X .80 = $40,000).

The borrower would receive $40,000 in a lump sum for use on whatever project or bill he wished to resolve. Repayments begin immediately on a monthly basis at a fixed interest rate. The rate will vary, depending on the lender and your credit score. The typical repayment period is spread over 25 years. In 2015, home equity loan interest rates average around 6%, with some as low as 4%.

Buyers Beware

Home equity loans can be very useful if the goal is to gain quick access to money and use it to increase your home’s value or improve your future job prospects by getting a college degree. However, there are downsides that should be considered before making a final decision.

A home equity loans is a secured loan, meaning your house is at risk because you have put it up as collateral. If unforeseen circumstances arise like a job loss or serious medical condition and you are unable to make payments, your home could go into foreclosure.

There is the matter of closing costs and interest rate charges that can add up quickly if you already are paying a mortgage. There also is the possibility of an early-termination fee, if you decide to pay it off early.

Another serious issue is volatility in the real estate market. Home equity is not static, meaning if the market plunges, like it did in 2008, home values can decrease, affecting the equity you have in your home. When volatile markets affect home equity, it can make it very difficult to sell your home.

If the real estate market in your area is prone to dramatic swings, it may be wise to consider other options, such as mortgage modifications, as an alternative to home equity loans.

Whenever you decide to borrow money – whether it is to pay the bills or buy a luxury item – make sure you understand the agreement fully. Know what type of loan you’re receiving and whether it is tied to any of your belongings.

Also, familiarize yourself with your repayment terms: what your monthly obligation will be, how long you have to repay the loan and the consequences of missing a payment. If any part of the agreement is unclear to you, don’t hesitate to ask for clarifications or adjustments.

How Do Personal Loans Work?

Find out how a personal loan works every step of the way.

Looking to apply for a personal loan but want to know more? Find out how they work and how you can apply. Whatever you're looking to take out a personal loan for – to finance a new or used car purchase, consolidate debt pay for a holiday or even cover wedding costs – there are a variety of personal loans to choose from. Use the guide below to help you choose the right one for your needs and situation.

How do personal loans work?

Personal loans work in very much the same as any other type of loan. You borrow a certain amount of money from a bank or lender so that you can pay for the things you need to. You will have an agreement with the lender to pay back your loan in monthly, fortnightly or weekly repayments.

Essentially, a personal loan helps you fill a short-term or long-term need for finance. You apply for a loan from a lender who then assesses your suitability for the loan, and if you are approved the lender will send you the funds for the loan. Your repayments will include the principal loan amount plus fees and interest. If you make your repayments as set out in your loan contract, your entire loan will be repaid when your loan term ends.

The personal loan process

Jump ahead to one of the steps in the personal loan process to find out more about it.

Comparison Eligibility Application Approval Loan funding Repayment Loan closure

Step 1: Comparison

Finding the right personal loan is the first step of the process. There are a few parts to this, the first being choosing the type of personal loan you want to opt for. Here is a breakdown of the main types of personal loans available:

Car loans

Secured personal loans

Unsecured personal loans

Short term loan

Personal overdraft

Personal line of credit

After you've decided what type of personal loan you want to apply for, here's how to compare the personal loan offers from different banks and lenders:

Loan amount. What is the minimum and maximum amount the lender lets you apply for and is it enough?
Loan terms. What are the minimum and maximum loan terms? Usually terms of between one and seven years are available, but terms differ between providers.
Fees. Check for upfront fees such as establishment or application fees and ongoing fees such as monthly or annual fees. These will need to be incorporated into your loan amount.
Interest rate. Is the rate fixed or variable? Is the rate competitive?
Repayments. Once you know your loan amount and terms, you can use a loan repayment calculator to see if the repayments will be affordable on your budget.
Repayments. Can you choose between weekly, fortnightly or monthly repayments? Can you make extra repayments without a fee? Can you repay the loan early without penalty?
Step 2: Eligibility

Lenders have set minimum eligibility criteria for their personal loans. This can include any of the following:

Age. You will need to be 18 to apply for a loan for Australia. Some lenders may require you to be over 21.
Income. You may need to earn over a certain amount to be eligible to apply for a loan. This may be $35,000 or lower, for example, $24,000. Find out more about borrowing on a low income here.
Employment. Most lenders will require you to be employed, but some will consider unemployed applicants. Some lenders will also require you to be out of your probation period or to be employed full-time. You can find lenders that consider casual employees here. Some lenders may also consider applicants receiving Centrelink payments.
Residency. You may have to be an Australian citizen or permanent resident to be eligible for a personal loan, although some lenders consider temporary residents.
However, even if you meet the minimum requirements for a loan you will not be approved unless you can prove you can afford the repayments. Lenders determine this by looking at your income, your debts and the stability of your employment.

Step 3: Application

The application process for a personal loan differs between lenders. Generally, you will have the option of applying online or in-branch (if the lender has branches) or over-the-phone. You can find a list of documents and information required to complete the personal loan application on finder.com.au review pages and on the lender's website and may include any of the following:

ID. You will need to provide your driver's licence, passport or a form of photo ID.
Proof of income. Depending on the lender you'll need three to six months of payslips, bank statements and two years' of tax returns if you're self-employed. If you receive Centrelink you will need receipts to show your income.
Other financial documents. If you have other debts, such as loans or credit cards, you will need statements from those accounts.
Online applications usually take about 15 minutes to complete.

Step 4: Approval

Some lenders can give you an answer instantly while others may take a few days or weeks to approve you. There are two forms of approval: full approval or conditional approval.

Conditional approval usually takes less time but is given pending more information from you, such as additional payslips or documents relating to your assets or debts. Lenders may just ask for this information and not offer any conditional approval. This is to help them make a more informed lending decision.

Full approval is given when you have supplied sufficient information for the lender to make a decision the lender has approved you for the loan.

Step 5: Loan funding

Your loan can be funded in a number of ways depending on the type of loan it is and what you are using it for. For example, when you take out a car loan the lender may pay the car seller directly. This is often the same case with a debt consolidation loan as well, with the lender directing funds to your debtors directly rather than to you.

If the loan is an unsecured personal loan the funds will be sent to an account you nominate. Some lenders can transfer funds on the same day you apply while others might take a few days following approval.

Step 6: Repayment

Most lenders will allow you to choose your repayment structure. That is, weekly, fortnightly or monthly repayments. Generally, the more often you repay your loan the less interest you will pay. When choosing your repayment structure you may also want to consider additional and early repayments.

Find out if your lender will charge fees for additional repayments
Check if your lender has restrictions on how much you can repay extra per year (generally fixed rate personal loans have this)
If you're planning to repay your loan early, check if there is a penalty you will have to pay
Step 7: Loan closure

If you are simply making your repayments as set out in your loan contract, then your loan should be closed following your final repayment. However, if you are planning to repay your loan early, it's a good idea to call the lender and get a final payout figure if you're getting close to paying off your loan. This is to ensure the loan will be closed when you make your final payment and you won't be charged any unexpected interest.

Questions we've been asked about how personal loans work

Do I have to pay the application fee before I apply for the loan?

No. If an application fee is charged with the personal loan you're applying for, it will be added to your loan amount once you're approved. It will then be paid off with your current repayments.

Are there any hidden fees or charges?

As with any financial product there will be fees and charges payable by you to your lender. These may include approval fees, repayment fees, establishment fees and redraw fees just to name a few. It's important you read and understand your loan contract before applying. If there is any wording you are unsure of it's important that you ask your lender.

Can you explain what a redraw is?

If you've paid extra funds into your loan account, you may be able to access these funds if you loan allows it. If it does not affect your repayments or your total outstanding balance you could withdraw these funds.

What about a drawdown?

This is simply a word to describe when the loan funds are actually made available to you by your bank.

What is the difference between variable and fixed rate loans?

When you take out a variable rate loan the interest rate you are charged may change over the term of your loan. A fixed rate loan will have an interest rate that doesn't change.

Which is better – a fixed or variable rate?

This will be entirely dependant on your financial situation, goals and needs. If you want flexibility and the ability to make extra repayments and access any extra funds, then a variable rate option is one to consider. If you want stability and the peace of mind knowing your repayments won't change over the life of the loan, then a fixed rate could be for you.

How do I make my loan repayments on time?

You will need to find out what date your loan repayments are due and work out a budget accordingly. You can usually make payments via BPAY, bank transfer or direct deposit depending on what your lender offers.

I can't make my repayments this pay period – what can I do?

If you are struggling to make a repayment, you should immediately contact your bank or lender. They may defer a payment for a month or work with you on a solution. It's important to note you may be charged extra interest on top of this.

I want to pay out my loan in full. Can I do this?

You may be able to do this, but it is important to contact your lender to obtain a payout figure. You may incur break costs and other fees and charges.