Whether it is updating a kitchen, covering medical expenses, consolidating debt, or refinancing your mortgage, there are times in life when you need access to cash. One possible way to get the money you need is through a home equity loan which relies on the equity you have available in your home.
What is equity? Good question! Equity is the difference between what you owe on your mortgage and what your home is currently worth. Every month that you pay your mortgage you gain a little more equity which can be taken out in the form of a home equity loan. There is a lot to learn about this type of loan but it’s well worth your time to understand the benefits as well as what to expect when you decide to apply.
How Does a Home Equity Loan Work?
Home equity loans are a type of secured loan that uses the equity in your home as collateral. Homeowners repay the loan with monthly payments over a fixed term. The amount you can borrow is typically up to 90% Loan-To-Value, which means up to 90% of the home’s overall value. Your income and credit history also factor into the maximum amount a lender is willing to finance.
How Much Can You Borrow?
The maximum amount you can borrow with a home equity loan depends on the equity and the Loan-To-Value ratio (LTV). Follow the example below to determine how much you could potentially borrow.
To determine a home's equity, first, you need to know its market value. Then, you must subtract the balance on your mortgage from the market value. For example, you have $175,000 left on your mortgage, and the appraised value is $500,000. The home's equity is $500,000 minus $175,000 or $325,000.
To qualify for a home equity loan, you must have at least 10% equity in your home. To determine the equity percentage, calculate the LTV.
First, divide the loan balance by the appraised value. Then, multiply the result by 100. Subtracting the number from 100 gives you the percentage of equity in your home. For example, dividing the loan balance of $175,000 by the appraised value of $500,000 results in 0.35. Multiplying 0.35 by 100 equals an LTV of 35%. Subtracting the LTV from 100% gives a percentage of equity of 65%.
The maximum loan amount cannot exceed 90% of the home's appraised value. In the example, 90% of $500,000 is $450,000. From the $450,000, subtract the balance due on your mortgage, which is $175,000. The difference between the appraised value, which is $275,000, is the maximum loan amount.
How Can You Use a Home Equity Loan?
Using the equity in your home to pay for expenses is a great low-rate way to make the things you need affordable. Home equity loans can be used for endless possibilities. Most borrowers use the loans for home improvements, debt consolidation, college tuition, medical expenses, or to refinance their mortgage.
Are Home Equity Lines of Credit the same as Home Equity Loans?
A home equity line of credit or HELOC differs from a home equity loan because it operates as a revolving line of credit like credit cards where you only make payments on the amount you have borrowed. For example, you have a HELOC of $100,000, you spend $20,000 to put on a new roof, your monthly payments would be based on the $20,000, not the $100,000.
It is also different because they come with a variable interest rate based on the Federal Reserve's prime rate, versus a fixed rate, and they are structured in two parts, the draw period (when you can withdraw money) and the repayment period. Payments must still be made in the draw period, but typically they just reflect the interest due.
They are similar in that the maximum loan amount a borrower can access from a HELOC is the same as the amount they would qualify for with a home equity loan, which is 90% of the home's equity.
How Long Does It Take to Get a Home Equity Loan?
Most lenders say it takes between three and six weeks to close on home equity loans, but not all loans and lenders are created equal. Some loan processing can take less or more time depending on the complexity and completeness of the associated paperwork as well as if the decisions are made locally or at a corporate headquarters. To qualify for a home equity loan, most lenders will check to see if you meet the following criteria:
- You have at least 10% equity in your home.
- You have a credit score above 620.
- Your debt-to-income ratio is below 43%.
- You have sufficient income to make payments.
- You have a reliable payment history.
If your credit score or history is poor or your debt-to-income ratio is high, you should consult your local lender to see what options are available.
Before you start the application, having these documents on hand will help ensure you receive your money as soon as possible:
- Deed of property
- Verification of income
- Two years of tax returns
- Tax assessment
- Mortgage balance
If the loan is for debt consolidation, you may also need to provide a list of the debts to be paid and the associated amounts. Another factor that may delay your loan approval involves having your property appraised by a qualified appraiser. To minimize the risk, try to arrange for an early appraisal date.
Faster Alternatives to Home Equity Loans
Home equity loans may take too long for your timeline or may not be the right financing option for everyone. Fortunately, there are alternative financing options such as the following:
Home Improvement Loans
Home improvement loans are a great financing alternative if you are looking to pay for an upcoming home improvement project. They are unsecured personal loans typically offering a fixed rate and a fixed term for repayment. They do not use your home as collateral which may mean they feature a higher interest rate, but they do offer a much shorter approval process. Some local credit unions or community banks may approve your loan in as little as 24 hours. Be on the lookout for lenders that do not charge closing costs. These lenders do exist, and that means extra money in your pocket.
Want to see how affordable a home improvement loan maybe? Check out a free online home improvement loan calculator to see how your loan would impact your monthly budget.
Personal Loans
Personal loans are typically unsecured loans from a lender. They have a fixed interest rate, fixed monthly payments, and flexible repayment terms so you can customize a monthly payment that fits into your budget. There is no collateral needed so with just your signature, you can fund your next adventure.
Credit Cards
If you are looking to cover an unplanned emergency or an upcoming project, credit cards may offer the fast money you need. If you can find a 0% Annual Percentage Rate credit card, you can eliminate interest payments during the promotional period. If you cannot repay the full amount within the promotional period, you may end up paying more in interest in the long run.
Can’t find a 0% interest credit card? Maybe a rewards or cashback card is a better fit. Make sure to do your research to know the pros and cons of every possible financing option to find the one that best fits your needs.
How to Get a Home Equity Loan
If a home equity loan is the best solution for your needs and timeline, the best way to get one is to shop around and compare interest rates, finance charges, and any possible fees.
Always start by contacting your local credit union or community bank to discuss the products and features they offer. They often have a better understanding of the local market, which can help when discussing financial options that involve your home’s value. They also typically make their loan decisions locally, which means a faster turnaround time for you.