After taking out a mortgage and becoming a homeowner, you are likely beginning a long journey, especially as it pertains to your finances, in your new home. But as the years go by, you may want to renovate your home, or even expand it. This is when a home equity loan can become extremely useful. A home equity loan is essentially a second mortgage that enables you to tap into your home’s value as collateral to access cash. You can shop for a home equity loan when your home has built up enough value that it is worth more than what you owe on a mortgage. This is why home equity loans can sometimes be a great financial product for homeowners that are looking to tap into some cash, which can certainly happen after a few years in the same home stirs up the desire to design a new kitchen or remodel the basement. But like any personal finance tool, especially when it comes to loans, home equity loans may not be the best option for all consumers, while also having warning signs to look out for. True Quote Mortgage’s home equity loan guide will make you aware of those warning signs, in addition to trying to help you decide if a home equity loan is right for your specific financial situation. And if it is, we have also featured some different home equity loan lenders, each with their own respective set of qualifications and terms, to help you compare the various companies and hopefully land on the best one when finally deciding on a home equity loan. Keep going to compare the best home equity loan lenders in 2019 and to wrap your head around home equity loans, including the pros and cons, how to get one, the alternatives, and if you will qualify.
A home equity loan is a kind of second mortgage that allows you, the homeowner, to utilize your home’s value as collateral to access cash, usually a large amount, which makes home equity loans a great option for major home renovations or additions. Specifically, home equity itself is the difference between the value of your home and the amount of money that you still owe on your mortgage. So, a home equity loan can only be considered when you have built up enough value in your home that it outweighs the mortgage debt you still owe. For example, if your home has amassed a value of $400,000 while you still owe $250,000 on your mortgage, than you can potentially borrow $150,000 via home equity loan that uses your house to guarantee the loan.
Since you are placing your home as collateral, home equity loans are often easier to qualify for, and you can usually receive a pretty significant amount of cash through an equity loan. Depending on the amount of equity you have built up in your home due to an increase in value and a decrease in outstanding mortgage debt, you will see that difference in the form of a large lump sum of cash from the home equity lender that you decide on. This home equity loan will repaid by you at a fixed interest rate through set and consistent monthly payments until it is fully paid for. Terms for home equity loans vary and can be as short as five years or as long as 15 years.
As discussed previously, your home’s equity is the difference between the market value of your home and what you still owe on your mortgage loan.
Here is how we get there:
Your home’s value can shift dramatically in just a few years and is impacted by factors like the local education system, proximity to corporate hubs and job centers, and crime. While you can always go online and research the prices of comparable homes in your area, it is probably best to receive an estimate from a local real estate agent. Your eventual home equity lender will have the property appraised to determine the value anyway.
After getting a solid estimate of your home’s market value, you simply subtract what you still owe on your mortgage, in addition to any other debts that are secured by your house.
Sometimes a home equity loan lender will only allow you to borrow a certain percentage of your home’s value. For example, how much cash can you access if your home is worth $500,000, while your outstanding mortgage balance is $250,000, and your lender is letting you tap into 90% of your home’s value? Since 90% of $500,000 is $450,000 (500,000 x .90), and you still owe $250,000 on your mortgage, than you will be able to access $200,000 (450,000-250,00) via home equity loan. As mentioned before, you would then receive this $250,000 through a lump sum of cash and it will have to be repaid at a fixed interest rate and with consistent monthly payment over the term of the loan.
Home equity loans are not for every homeowner, especially if you have not built up enough value in your home yet, but also because home equity loan lenders have certain requirements that home equity loan borrowers must meet.
Some of the minimum requirements to qualify include:
A credit score around 660 and above; any score above 700 will very likely lead to qualification
A maximum loan-to-value ratio (LTV) of 80%, or if you have built up 20% equity in your home
A proven history of repayment on other loans
Manageable debt-to-income ratio, preferably lower than 43%, that won’t climb significantly higher after the home equity loan
Every home equity loan lender is different, and there are always exceptions to these minimum requirements above. For example, you may still get approved for a home equity loan even with a poor credit score if you have a high home, plenty of home equity, or a low debt-to-income ratio.
On that same note, lenders will always have different borrowing standards and can offer different rates on home equity loans, which is why it is important to compare the various lenders.
If you are unable to qualify for a home equity loan, or if you just want to learn more about other options available to you, we have listed out a few alternatives to home equity loans.
When it comes to home equity loans, the most commonly compared financial product is a home equity line of credit (HELOC).
First things first, these two financial products are not the same thing, though you may have heard the two terms used interchangeably.
Next, whereas with a home equity loan you receive a lump sump of cash up front from the lender, with a HELOC you have a maximum amount that you can borrow, or a line of credit, that you can dip into at any point.
In regards to repayment, a home equity loan comes with a fixed interest rate that should remain the same for the duration of the loan; monthly payments on home equity loans will remain consistent, and each payment reduces the remaining loan balance, in addition to covering interest costs.
For a HELOC, since you can borrow from it whenever and in different increments, payments can be small in the early years, but eventually you will have to start making consistent monthly payments until the loan is paid off.
Since HELOCs give you the power to manage your loan balance and thus your interest costs, like a credit card, they are seen as the more flexible option over home equity loans. However, your lender also has its own power to freeze your line of credit so the flexibility does also have risk.
Additionally, HELOCs come with variable interest rates, which can often make budgeting for monthly payments less predictable. Home equity loans, on the other hand, have a fixed interest rate.
Another option for financing available to you if you either do not like home equity loans or cannot get approved is a personal loan.
A personal loan can be accessed through a bank, online lender, or credit union, and can be used for a wide variety of things, like affording a wedding, purchasing a pet, or consolidating credit card debt.
This makes the flexibility that comes with personal loans competitive with home equity loans. However, you may find it difficult to find favorable repayment terms, including a low interest rate, when shopping for a personal loan if you have a poor credit score, a high debt-to-income ratio, or low income.
One other alternative to a home equity loan is a cash-out refinance. Whereas a HELOC or home equity loan is more of a second mortgage, a cash-out refinance actually replaces your mortgage with another one that amounts to more than what you still owe on your mortgage.
This additional part of a cash-out refinance is what you are cashing out on and will be available for you to spend. A standard mortgage refinancing would simply replace what you originally owed on your mortgage with the exact same amount.
If you can secure a lower interest rate on a cash-out refinance than what you have on your original mortgage, than this option may make sense for you.
If you do decide to go with a home equity loan, you want to spend time checking out multiple lenders and comparing what they have to offer as this is a serious financial commitment.
Each lender will have their own home equity loan terms and fee structures, in addition to their respective strengths and weaknesses. For example, some lenders may still give you a solid deal even if your credit score is a bit low, while other lenders might have exceptional customer service.
The Consumer Financial Protection Bureau and the Department of Treasury suggest that you review home equity lenders based on the following:
For example, lenders have their own eligibility requirements and you don’t want to waste your time applying with a lender that will reject you, while each lender also has their own minimum loan limits so you want to avoid applying to one where you can’t meet the minimum.
Further, while almost all home equity loan lenders will offer a fixed interest rate, some may actually come back to you with a variable rate so it is important to research that. Additionally, lenders approach fees differently so while one might offer no fees but a higher interest rate, it may be wiser to go with a lender that has a fee but a more affordable interest rate.
Finally, each lender is going to have their own level of customer satisfaction, which is why it imperative to conduct your research and look into reviews offered by the likes of J.D. Power.
Like most aspects of life, there are always going to be some bad apples in the group, and it is no different for home equity loan lenders.
When in the market for a home equity loan, be on the lookout for the following warning signs when evaluating home equity loan lenders:
Right before closing on your home equity loan, the lender changes up the terms of your loan, maybe even the interest rate. This could be a sign that the lender was trying to gain more favorable terms believing that it was too late in the process for you to back out.
The home equity loan lender pushes hard for you to buy an insurance package for your home equity loan. If insurance is a must, you can just get your own policy.
If a contractor tries to get you to agree to home improvements if they help you find financing through a home equity loan lender, this could be a scam. As soon as the improvements begin, you must sign on for an unfavorable home equity loan and the contractor can receive payment without delivering high quality work.
You have gotten approved for monthly payments that you really shouldn’t be getting approved for as you can’t afford it. It is important to remind yourself that a home equity loan lender can claim your home if you default on the loan.
Loan flipping is another thing to keep an eye out for. If the home equity loan lender strongly pushes you to refinance the loan over and over again, they might be looking to cash out on extra fees, amongst other things.