Things happen unexpectedly, and sometimes having a reliable source of money to tap into can be a big help. For homeowners, borrowing from your home equity might be worth considering.
Depending on your situation, accessing that potential cash involves an application process and meeting certain eligibility requirements. In general, you’ll have two main options: A home equity loan or a home equity line of credit (HELOC).
Learn more about which situations warrant tapping into your home equity, how to choose between a home equity line and HELOC, and what you’ll need to qualify.
When To Borrow From Your Home Equity
Being able to borrow against your home’s equity can seem like a godsend, but like most financial decisions, there are pros and cons.
On the positive side, home equity can give you access to a large sum of cash for a relatively lower cost than some other types of loan or credit products. And there could be tax advantages, depending on how you use the money.
Because you’re using your home as collateral when you tap into home equity, that also means there’s more risk to you, should a situation arise in which you have trouble paying back the loan. Understand that you’re putting your home on the line.
In general, a home equity loan or HELOC is recommended for things like making home improvements (which can increase your home value and qualify you for a tax deduction) or paying off high-interest debt. Some people also use home equity funds to pay for education or medical expenses. At the same time, personal finance experts would likely try to talk you out of borrowing from your home equity to pay for a dream vacation or luxury car. Ultimately, however, you are not limited on how you can use the cash or credit line.
Home Equity Loan or HELOC?
|Home Equity Loan||HELOC|
|A second mortgage on your home that gives you a lump sum of cash. Good for borrowers who need a large amount of money for a substantial purchase or debt.||An approved credit limit that you can draw from as needed. Good for borrowers who want easy access to cash in case of a financial emergency.|
|Monthly payments are fixed for the life of the loan||Interest rate is variable|
|Payments begin the month after the loan is disbursed||You may be able to make interest-only payments during the “draw period" of the loan (though you can pay principal, too, if you wish). Once you enter the repayment period (after the draw period ends), you must begin paying back any principal owed plus interest.|
|You can get a tax deduction on interest you pay back if used toward home improvement.||HELOCs also qualify for a tax deduction on interest you pay back if used toward home improvement.|
Requirements for Home Equity Loans
Just like any other home loan, you’ll have to prove your eligibility in order to borrow against your home equity. Here are the major home equity loan requirements:
Your Home’s Equity
Simply put, you need to have ample equity in the home in order to borrow from it. What this means is that there must be a sizable difference between your home’s current value and your mortgage balance. The more equity you have, the more you can borrow. Although lender rules may vary slightly, in general, you can usually borrow up to 85% of the equity in your home.
So, for example, if your home value is appraised at $200,000, and your current mortgage balance is $120,000, you would likely be able to borrow up to $50,000.
To determine your home’s current value, the lender will require you to get a home appraisal. If you haven’t done one in a number of years, this can work to your advantage, especially if you’ve made any home improvements or if home values in your area have risen.
Credit score is a big factor whenever you want to borrow, and home equity loans are no different. Lenders generally look for a score of 700 or more because that is considered to be in the good-to-excellent range. Higher scores will also help you qualify for lower interest rates.
Your Ability To Repay
Lenders will want to verify your income and job stability in order to make sure you have the means to pay back the loan. Just like when you first got your mortgage, you may be asked to submit documentation, including pay stubs, W-2 forms, tax returns, bank statements, etc.
Lenders are always concerned with how much of your monthly income is needed to pay your debts. The benchmark percentage is usually 43%, although some lenders may go slightly higher, depending on other factors.
How To Apply and Get Approved for a Home Equity Loan
If you’re interested in how to get a home equity loan or HELOC, start by doing a bit of preparation before you begin working with a lender. Once you do your due diligence, you’ll be ready to apply for a home equity loan.
Before You Apply
Check your credit score, evaluate your income, and take a look at what you owe on your current mortgage to make sure you meet the minimum requirements for borrowing. You can also do some research and begin to shop around for quotes from a couple of home equity and HELOC lenders.
Start the Application Process
Most home equity loans or HELOC applications can be started online or over the phone. You can also go in person to a local bank branch. Be prepared to supply basic information about your income and assets and to give permission to run a credit check.
Get Your Home Appraised
Once your credit is approved and your income is verified, the next step is to get an appraisal on the home. The lender may set up this appointment for you, but it’s your responsibility to pay for it.
Prepare for Closing
After the appraisal, the lender will let you know if you are fully approved, and the exact amount that you are able to borrow. You’ll also be given details about the full terms of the loan/credit line, including the interest rate and repayment schedule. If you’re happy with the offer, you can go ahead and schedule a closing. At closing, you’ll sign all of the loan documents to make it official. Closing costs will be added to the loan amount; fees vary by lender.
Access your funds
Once the closing is completed, you will have three days to back out of the agreement if you change your mind. After that, you will receive your money (for a home equity loan) or be given access to your HELOC account to make a withdrawal.
Frequently Asked Questions (FAQs)
How much equity can I borrow from my home?
Most lenders allow you to borrow up to 85% of the home’s equity.
How long does it take to get a home equity line of credit or loan?
The entire home equity loan or HELOC process should take a few weeks at most, depending on how long it takes the lender to verify your documentation and income, when you schedule the appraisal, and how long it takes to get that report. These days, most of your documents can be easily uploaded, which can speed up the process.
How hard is it to get a home equity loan?
As long as you have enough equity in your home and meet credit and income requirements, getting a home equity loan is a fairly easy process. If you are falling short in the credit department, you can work to make improvements to your score and try again in a few months. If your debt-to-income ratio (DTI) is too high or you don’t have enough equity, then you should explore other options.