How To Get A Home Equity Loan And What You Need To Consider
As you pay off your home mortgage, you gain equity in your house. This equity is very valuable as an asset. In fact, if you need money for any reason, one of your options is to use that equity to obtain a loan. Such loans are known as home equity loans and can be quite beneficial to homeowners in need of extra funds. However, understanding what a home equity loan is and what are the potential advantages and disadvantages is important before you decide to take one out. Here we present an in-depth overview of home equity loans that will help you to make a much more informed decision.
What Is A Home Equity Loan?
Home equity loans are loans that are taken out against the equity that you've built up in your home, and there are two types. The first type of home equity loan works like a second mortgage. You'll be provided a loan in one lump sum, which you will then have to pay off every month with interest. The second type is known as a HELOC (Home Equity Line Of Credit) loan. A HELOC loan is a line of credit that you can withdraw from at any time. You only make payments and pay interest based on the amount that you actually withdraw, not on the entire line of credit that you're provided.
Who Is This Suited For?
Home equity loans are best suited for large expenses. If you only need a few thousand dollars, it makes more sense to just get a personal loan from your bank. However, if you're looking to invest in a home improvement that's going to cost $15,000 or you want to pay off your student loan debts, then a home equity loan can be a good option.
HELOC loans are a good option for homeowners who foresee the need for routine investments in their properties. For example, people who own several rental properties may want to take out a HELOC loan so that they can pay for various renovations and repairs over a period of time. You can use home equity loans for anything you want, whether it's to renovate your home, pay off debts, enroll in university, or even to take a vacation.
Things To Consider Before You Apply
On the surface, a home equity loan might seem like an easy decision, especially if you need money and you have equity in your home. However, you should consider a few things before you decide to apply. You should always perform due diligence when it comes to taking out a significant loan, after all. Here are a few things to consider:
Why Are You Borrowing?
Do you have a good reason for taking out a home equity loan? For example, a home equity loan might be worth it if you're investing in a home improvement that will improve the value of your home. However, you're just taking out the loan to have some extra money on hand to spend on whatever you want, you might want to reconsider. You'll have to pay interest on the money you take out, after all. If you already have major debts that you're paying down, adding more debt may not be the best idea. You're also putting your equity up as collateral, which means if you don't pay back your loan, you could lose your home.
If you're using the loan to pay down one of these debts, make sure you do the math. Determine what you'll end up paying in interest over the long run to determine whether paying off an existing debt will actually save you money. Otherwise, it may not be worth it.
Calculate Your Loan-To-Value Ratio
You will need to have a loan-to-value (LTV) ratio of 80 percent or less to qualify. It's determined by dividing the amount owed on your mortgage by the value of the house. Essentially, the LTV ratio represents the amount of equity you have in your home. The more equity that you have in your home, the more you'll be able to borrow.
If you only need a small loan, then a personal loan might make more sense than taking out a home equity loan since there's less risk involved (especially for unsecured personal loans). If you think you can pay off the loan quickly, a different type of loan might be a better option despite the fact that the interest rates may be adjustable or a bit higher than that of a home equity loan. It all depends on what your situation is. Research other loan alternatives to compare rates and terms before making your decision.
Advantages Of Home Equity Loans
Some of the advantages of taking out a home equity loan that you will want to keep in mind when making your decision are these:
- They can provide access to a significant amount of money - If you need a large amount of money (for example, to start a business or to make substantial additions to your existing home), then a home equity loan might be one of the only ways that you can get it. This is especially true if you have a lot of equity in your home.
- You can use home equity loans for anything - You can use the money for anything you want, whether it's for home improvements, to buy a new vehicle, to start a business, to invest in another property, to pay off other debts, or for personal reasons. There's no limit on what you can use it for.
- Home equity loans typically have low interest rates - Compared to other types of loans, home equity loans are available at low and fixed rates. The fact that they are also fixed means that you can easily budget for them.
- Home equity loans are easier to qualify for - If you have bad credit, it's easier to qualify for a home equity loan than another type of loan since you're putting up your house as collateral. This helps offset the financial risk the lender is taking, however, they may require that you have a lower debt-to-income ratio if you do have bad credit.
- You can deduct your mortgage interest - The interest that you pay on your home equity loan can actually be written off when you file your taxes. However, you can only do this if you're using the money for home renovations on the property that you're taking the loan out for.
Disadvantages Of Home Equity Loans
Although there are some significant advantages to taking out a home equity loan compared to other types of loans, home equity loans are not without their disadvantages. The following are a few of the potential disadvantages of a home equity loan:
- You'll have to pay closing costs - A home equity loan is similar to a mortgage in that you will have to pay a number of closing costs and fees. These can be rolled into the loan itself, but obviously they add to the overall cost of taking out the loan.
- You have to put your home up as collateral - The biggest disadvantage of taking out a home equity loan (whether it's a standard home equity loan or a HELOC loan) is that you are putting the equity you have in your home up for collateral. This means that if you default on your loan payments, the lender can foreclose on your house.
- You'll take on significant debt - A home equity loan is a lot of money to take on as debt. If you're not capable of handling the additional debt, it could hurt you financially. For example, you'll want to make sure you pay your home equity loan debt before paying credit card debt because you don't want to lose your house. If you begin putting off other debt payments, it could hurt your credit score significantly as well as cause your debt to grow as a result of interest and late/missed payment penalties.
How To Get A Home Equity Loan
If you've made the decision to get a home equity loan, you'll want to know how to go about applying for one. The following are steps you'll need to take to apply for a home equity loan:
1. Get Your Credit Report Ready
Even though you don't need perfect credit to qualify since you will be using your home as collateral, lenders will still look at your credit report. Generally speaking, most lenders will require a credit score of at least 620. You will also need a debt-to-income ratio of 43 percent or less. If you have bad credit, a lower debt-to-income ratio will help. You will also need to show proof of income. All of these factors help lenders determine if you are financially capable of paying back your home equity loan on time and in full.
2. Speak With Multiple Lenders
You're not limited to taking out a home equity loan from the lender through which you obtained your current mortgage. Different lenders have different eligibility requirements and may charge different fees, so shop around.
3. Determine Your Available Equity
If you've recently bought your home, then the initial appraisal you got might be a good indicator of how much your home is worth. However, if you've owned your home for some time, it may be outdated. A lender will perform an official appraisal when you apply for a home equity loan; however, you'll want to get a sense of how much equity you have available before you decide on a lender. You can get a ballpark figure by doing some research online to see how much properties that are similar to yours have sold in your area over the last six months to a year. Subtract what you still owe on your mortgage and you will have an idea of the amount of equity that you have in your home.
4. Compare Rates
When speaking with lenders, find out how much they will charge in interest. If you know what your credit score is and what your debt-to-income ratio is, they should be able to give you an accurate estimate.
5. Have Your Lender Manage the Rest
Once you've found a lender that you want to work with, they will help guide you through the rest of the application process. The lender will look over your credit report and determine whether you'll qualify or not. They will then tell you what documents you need to gather for the loan to be processed. As long as you're working with a reputable lender, they should be willing and able to address any concerns or questions that you might have.
Is It The Right Loan?
It can't be stressed enough how important it is that you weigh the potential benefits and drawbacks of taking out a home equity loan, whether it's a standard home equity loan or a HELOC loan. Just because you qualify doesn't mean that it's a good idea. Weigh all of your loan options to determine whether a home equity loan is the right type of loan for your needs.
Unsure if this is the right loan for you? Get advice from one of our trusted advisers now!