Owning a home comes with many perks, one of them being that you no longer are paying rent for someone else’s property. Instead, your monthly payments go toward building equity in your own home. As a homeowner, tapping into your equity is a different way to borrow for home improvement projects, college tuition or other major expenses. Home equity loans come in different forms. In this blog, we will review the type of home equity loans available, the requirements needed and more.
What is a Home Equity Loan?
A home equity loan lets homeowners borrow money based on the amount of available equity in their home. It is a smart alternative to personal loans and credit cards. There are two main types of loans available by many mortgage lenders: A home equity loan and a home equity line of credit (HELOC), according to Bankrate.com.
Home equity loans are considered second mortgages that are secured by your property. They are popular because they do not require you to refinance your first mortgage, which is especially important if you are content with your current interest rate and payment. You can use the loan for whatever you want, including home improvements or any other major expense. Plus, home equity loans typically have lower interest rates than credit cards and personal loans.
The Different Types of Home Equity Loans
There are two types of home equity loans. Each has distinct features that you will need to consider, depending on your financial needs.
- Home Equity Loans: Home equity loans let you borrow a lump sum of money upfront that will be repaid over a specific amount of time or term. These loans tend to have fixed monthly payments and fixed interest rates that will not fluctuate over the life of the loan.
- Home Equity Line of Credit (HELOC): A HELOC lets you borrow from your home’s equity in a different way. Instead of a lump sum up-front, you will have a line of credit that you can draw upon as you need funds. The draw period is usually 10 years. During this time, you will only pay interest on the amount that you have borrowed.
HELOCs have a variable interest rate so your payments will fluctuate based on market conditions. Once the draw period is over, you’ll have a repayment period, which could be as long as 15 years, to repay the loan’s principal and interest.
How to Qualify
A home equity loan and HELOC generally have the same loan requirements. Most lenders require that a property have more than 20% available equity, that borrowers have a credit score of 680 or higher, and they have a stable, verifiable income history of more than two years, according to Investopedia.com.
There are lenders who may qualify you despite you not meeting certain requirements. But they will charge a higher interest rate due to the higher risk. To avoid paying more for your loan than you need to, focus on increasing your credit score to get the lowest interest rate possible.
How Much Equity Do You Need?
Getting approved for a home equity loan requires you to have a minimum of 20% equity in your home. Typically, the maximum amount you can borrow is 80% of your home's available equity, but that depends on the lender's requirements, says Investopedia.com.
What Happens After You Apply?
After you apply for a home equity loan, you may be required to obtain a home appraisal. A home appraisal is an evaluation of the home that will give lenders an idea of its value and the amount of equity available. If your home’s value has increased since you first purchased it, you will likely have more equity to work with. Alternatively, if the home’s value decreased since you bought it, there will be less equity to borrow, according to Investopedia.com.
Interest Rates
Interest rates on home equity loans fluctuate based on market conditions so your rate will depend on the timing of your application. Rates for home equity loans tend to be lower than other types of rates, such as credit cards and personal loans, because they are using your home as collateral. Remember that interest rates vary by lender so shop for the best rates possible.
The Application Process:
The application process for a home equity loan will be different for each lender. Overall, these are the typical steps that you will follow:
- Submit Application: The information needed on an application is usually the same for each lender. You will need to provide your full legal name, Social Security number, property information, income verification, current mortgage and, if adding a cosigner, that individual’s information, as well, says CNN.
- Appraisal: Depending on when your home was last appraised, the lender may require a new appraisal be done to reassess the value of your home, explains Investopedia.
- Underwriting: Once the application has been submitted and an appraisal completed, if necessary, the underwriter will assess all the information to determine your credit worthiness. Once the loan is approved, the application will move into the closing process.
- Closing: Once all applications are approved, you will sign your closing documents and a final review will be made by the loan officer before your funds are released to you.
Pros and Cons of Home Equity Loans
Choosing the right home equity loan depends on your unique financial situation. See the chart below for details about the pros and cons of such a loan.
Comparison of Home Equity Loan and Home Equity Line of Credit
| Home Equity Loan |
Home Equity Line of Credit |
| Pros |
Cons |
Pros |
Cons |
| Fixed interest rates for life of loan. |
If additional funds are needed, you cannot draw from the same loan. |
Ability to draw only the funds you need. |
Payments can fluctuate should the interest rates change. |
| Fixed monthly payments. |
Refinance is necessary to lower interest rates if they drop. |
Variable interest rates give the loan a chance of lowering interest rates automatically should they drop. |
Home is used as collateral so, if you default on loan, you may lose your home. |
| Fixed terms to pay back the loan. |
Home is used as collateral so, if you default on loan, you may lose your home. |
Open credit line that lets you draw from should you need to take more funds. |
Impulse spend may occur of how accessible the line of credit is. |
How TCU Can Help
Travis Credit Union’s Mortgage Hub is a wonderful place to start learning about home equity loans and HELOCs. We will also show you ways to improve your credit so you will get the best rate possible. If you are not yet a homeowner, TCU can help you become one. Get started at Traviscu.org today!