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.
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).
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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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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.
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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.
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