Getting a loan might not always be as easy as you think. Many lenders have strict requirements that can be difficult to meet. Sometimes your income is simply not enough. That is when home equity loans can be a lifesaver.
This type of loan enables you to borrow cash against the equity in your home. You get fixed interest rates, and the money is paid out in one single payment. Wondering how does a home equity loan work? We have got you covered as in this article, we are going to consider all aspects that you might find useful.
What Is a Home Equity Loan?
A home equity loan is a type of borrowing also known as a secondary mortgage. It allows borrowers to take out loans against their home’s equity. In simple terms, equity is part of your house that you actually own versus the remaining mortgage debt.
E.g., if your house is worth $200,000, and you still have to pay off $100,000, that means your current equity is 50%. These home equity loans tend to have fixed interest rates. This means that your monthly payment will remain the same over the entire term of the loan.
The duration of your borrowing will be fixed as well. Its length depends on various factors, such as the rates and the amount. The amount is calculated based on equity, and you can borrow up to 85% of what you own.
Average Home Equity Interest Rates
If you prefer stability and knowing the exact interest rates your loan will have, then you need to look into home equity financing. This type of lending provides borrowers with fixed interest rates. Until the financing period is through, the rate will not change.
The rates usually depend on the lender as well as other circumstances. They consider the duration of your loan, credit score, the amount you borrow, and so on. The average rate across lenders is around 8.50%.
It is difficult to determine what your interest rate might be. Some lenders allow for prequalification, so you can look for the best home equity loan without hurting your credit score. They will let you know upfront if you are eligible and of the cost of the loan.
How Does a Home Equity Loan Work?
Putting up collateral means that you will get lower interest rates with the majority of lenders. That is why home equity loans can seem very appealing. You will be getting a lump sum, and as a guarantee that you will pay it back, you have to set up your home’s equity.
Once you find a lender, you need to determine whether you meet the home equity loan requirements. You need to calculate your equity percentage and figure out your debts and expenses. Also, make sure to consider your income to decide if it will be sufficient.
After looking into the best home equity loan lenders, you can decide what is best for you. Then, you can start the application process. A lot of lenders will let you apply online as well.
Home Equity Loans vs. HELOCs
The main thing you need to know about the best home equity loan is that the money you borrow is secured by your house. This cash is paid out to you all at once. It has a fixed interest rate, and you have to make regular monthly payments.
On the other hand, home equity lines of credit (HELOCs) will give you access to a revolving line of credit. That means that you can take out the money you need at a given point. HELOC also uses your home as collateral, but it has a variable interest rate.
Even though the two options both use your assets as a guarantee, they are different in practice. HELOC works more like a credit card. The best home equity loan provides a single payment.
Should I Get Home Equity Loan?
Many people feel uneasy when it comes to collateral. The possibility of losing certain assets or your home is certainly not appealing. That is why you need to act responsibly and consider your financial situation first.
Home equity borrowing can be a great solution if you manage your finances right. Before getting one, ensure that your other expenses are covered, and your income is enough for repayment. Moreover, make sure that you will not be struggling to survive with all the bills.
Once you determine that you are all set in those fields, you should look into the possibilities. You should only get a home equity loan if you are positive that you can make regular payments. If handled right, it is a great way to save up with lower interest rates.
How to Use Home Equity Loans
The best home equity loan will not be limited to certain spending categories. They can be used for various purposes depending on your needs. It is not a good idea to use them for vacation or leisure, but there are many other ways to use these funds.
Here are some of the examples for the best uses:
- You can make home improvements and renovations.
- Use the funds to pay off your student loans.
- If you had high medical expenses, you can pay those off as well.
- When you are looking to make investments, such as real estate.
- Make large purchases, such as buying a new car.
- If you have aspirations and ideas to start your own business.
- Consolidate your debts and make them into a single payment.
- Pay for your wedding expenses, as this is a once-in-a-lifetime opportunity.
Pros and Cons Of Home Equity Loan
Getting a home equity loan is an excellent idea for some, but definitely not suitable for everyone. There are many factors to consider before getting one. There are both benefits and drawbacks to such an undertaking.
Here are some of the pros and cons to help you out:
| Pros | Cons |
| Fixed rates – The best home loan has set interest rates that do not change over the entire course of your borrowing. Your payments will always be the same. | Collateral – You are offering your home equity as a guarantee to the lender. This also puts you at risk of losing your share if you fail to make the repayments. |
| Large amounts – When you offer your home equity as collateral, you can get a loan of up to 85% of that amount. | Two mortgages– You will technically be paying off two mortgages, as equity is the share of the house you already paid off. |
| Lower interest rates – As the lender will have collateral in case you default with payments, you do not represent a risk to them. That is why they can offer low rates. | High LTV ratio – You cannot get approved for this loan if you do not have high equity. Even then, your loan amount has to be around 85%. |
| Money can be used for many purposes – There are no limitations on how you can use borrowed funds. |
Home Equity Loan Requirements
Collateral will definitely help you get a better deal, but this does not mean you automatically qualify for borrowing. There are many other conditions set by lenders. The requirements can vary based on the lending company.
The good part about that is that you can choose the best home equity loan for your financial situation. You need to find a lender that works for you and vice versa. Even though most requirements are specific, there are quite a few that apply across most lenders. To keep you informed, we are going to discuss them below.
Credit Score
Regardless of the type of your loan, a good credit history is always a plus. Lending companies will be looking into your background and asking for reports before giving you the funds. It can be a bit more difficult to get a home loan with bad credit.
The desired score for such home equity loans is around 700. But, as many people do not have such a high credit, you might even get by with 650 or less.
Lower scores are sometimes tolerated because you are putting up collateral. This means you are not much of a risk to the lender, and your credit history is not as relevant.
Debt-To-Income Ratio
Debt-to-income ratio or DTI is almost a self-explanatory term. It considers how much you owe versus your earnings per month. This is an important factor for many lenders. The lower the percentage is, the better.
If you are uncertain of how your DTI will affect your status, you can always check using a home equity loan calculator. The highest percentage that most creditors will allow is around 40%. This way, they can be assured that you will be able to make your monthly obligations.
To determine your debt-to-income ratio, lenders will consider all your previous debt, potential home loan debt, as well as interest rates and other costs. After that, the overall debt is divided by your income on a monthly basis.
Income
One of the major aspects that every lender cares about is your earnings. Your income must be sufficient to cover the monthly payments. Not only does it matter to the lending companies, but it should also matter to you.
Carefully calculate how much money you can set aside to pay off your debt. You do not want to end up struggling to pay for your basic daily expenses.
Apart from determining your eligibility, the monthly income also plays a role in the loan amount you can get. No creditor will let you borrow more than you can afford.
Payment History
To see whether you are a responsible borrower, lenders will look into your payment history. Did you pay off your home equity loans in time? Did you ever default on the payments? Do you struggle to pay your monthly bills on time?
All of these questions affect your score and ability to get a new loan. Home equity loans are a big responsibility, and you have to be a reliable borrower. If you have a history of failed or late payments, lenders are less inclined to approve your request.
Conclusion
Even the best home equity loans are not the right solution for everyone. There are many requirements you need to fulfill to get one. But, they are a great way to get a good loan secured by the equity in your house.
The equity is a part of the mortgage you already paid off. It refers to how much of your house you already own, expressed as a percentage. There are pre-determined percentages that you need to have in order to get the new loan. Once you evaluate all pros and cons, you can decide whether this option is for you or not!
FAQs
- Is it good to borrow from home equity?
If you plan on handling your loan responsibly, this can be an excellent option. You need to make regular payments and set the funds to good use.
- How much is a 25000 home equity loan payment?
Your payment will depend on the loan term, the interest rates, your reliability, and so on. On a $25,000 loan, the monthly payment can be anywhere from $350 to $2,500. You can use a home equity loan calculator to get a more specific amount for yourself.
- What credit score do I need to get home equity loans?
The lenders prefer a good or excellent credit score. Ideally, it should be somewhere between 680 and above.
- Are home equity loans expensive?
Interest rates on the best home equity loan are not that high. They can be expensive under certain circumstances, but they are cheaper than some unsecured loans.
- When is it a good idea to take out a home equity loan?
These borrowings are a great idea if you need money for a big expense, home improvements, or medical bills. If you are going to use the money irresponsibly, then this is not an option for you.
- What are the best lenders of home equity loans?
You can find these borrowings with many lending companies. But some of the best ones are Discover, Connexus Credit Union, U.S. Bank, and Flagstar.
