What is a home equity loan?
A home equity loan is secured by equity in your home. If you do not repay the loan as promised, the lender can reclaim your home (collateral), sell the property and recoup the loss.
One difference between a mortgage and other types of loans is that if the funds are used for renovations or additions to your home, you may be able to deduct interest.
Note: Before applying for a equity loan, make a plan of what to do if you run into a financial problem such as an unexpected illness or job loss. Because your home is on the line, it’s worth having an emergency fund that ensures that payments are made no matter what.
How does a home equity loan work?
When you take out a home equity loan, the funds are spread out in a lump sum and repaid in monthly installments. A home equity loan can be used for almost anything, such as travel, weddings or debt consolidation. Interest rates and monthly payments are fixed, making it easy to budget with confidence. The APR is usually lower on a equity loan than an unsecured personal loan because the lender has collateral that protects its interests.
Loan terms for most home equity loans range from five to 20 years, although they can be extended up to 30 years. There are no down payment or closing costs with home equity loans, although some lenders charge commissions.
How much can I borrow?
The first requirement is to have enough equity in your home to borrow. Lenders typically require borrowers to have at least 20% of the value of their home in equity. To find out how much equity you have available, the lender orders a home appraisal. The cost of home appraisal is added to the fees you pay at closing.
Suppose your home is valued at $ 350,000 and you have a $ 200,000 mortgage balance. That means you have $ 150,000 in equity. The next step is to calculate how much of these equity you are entitled to borrow. Most lenders allow you to borrow up to 85% of your available equity. So if you have $ 150,000 in equity, the maximum amount you could borrow would be $ 127,500 (150,000 x 0.85 = 127,500).
Mortgage share loan requirements
To qualify for a home equity loan, you must provide your lender with a collection of documents, such as:
- W2 or 1099 income declarations for the last two years
- Bank copies for three months
- Federal tax returns for two years
- Recent payroll executives
- Proof of other sources of income such as social security payments or tips
- Proof of investment income
A lender will also check:
Debt to income ratio (DTI).
To qualify, your DTI usually cannot be higher than 43%. To calculate your DTI, add your monthly payments (for fixed costs, such as mortgages, auto loans, child support payments, credit card payments, and other loan payments). Once you have this total, divide the number by your monthly gross income (the amount you earn before taxes).
For example, if your monthly bills are $ 3,000 and your monthly gross income is $ 9,000, your DTI is 33%. (Mathematics looks like this: $ 3,000 ÷ $ 9,000 = 0.33).
A lender will perform a credit check, with most lenders looking for a FICO® Score of at least 680. While you may be eligible for a loan with a lower credit score, the interest rate is likely to be higher.
What is the difference between a mortgage and HELOC?
It is easy to confuse a home equity loan with a home equity credit line (HELOC), but they are very different loan products. Here’s how they differ:
A mortgage equity loan is disbursed in a lump sum, and the funds can be withdrawn from a HELOC as needed. Similar to how a credit card works, once you have repaid the money you have borrowed from a HELOC, the money is available for lending again.
A mortgage equity loan is provided with a fixed interest rate and a fixed monthly payment, while a HELOC has a variable interest rate and variable minimum monthly payments. Once a home loan is disbursed, the entire loan must be repaid over time. With a HELOC, you only repay the funds you withdraw, plus interest.
How To Find The Best Mortgage Lenders
Like the best mortgage lenders, the best mortgage lenders have many things in common, such as:
- Low interest rate
- Repayment terms that work with your budget
- Strong customer service
It pays to shop when you are looking for a home equity loan. Most lenders perform a light credit check before making a loan offer. Unlike a hard credit check, a reasonable check does not affect your credit score. Only when you decide to accept a loan offer does the lender perform a tough credit check. And even if the credit check lowers your score by a few points, you can still count on it to recover after a few timely payments.
Advantages and disadvantages of mortgages
Like most things in life, mortgages have advantages and disadvantages. Here, we analyze the pros and cons.