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If you’re a homeowner who’s been diligently paying off your mortgage over the course of time, you’ve built up home equity that you can tap into. Whether it’s for cash to fund home renovation projects, a streamlined way to consolidate your debt or an opportunity to fund your dream wedding, accessing your home’s equity can be a smart way to borrow money if you’re in need of extra cash. Take some time to learn more about how home equity loans work and if they might be a good fit for your personal financial situation.
What Is A Home Equity Loan?
Sometimes known as a home equity installment loan or a second mortgage, home equity loans allow homeowners to borrow against the home equity they’ve built up in their homes over time. The loan amount that a homeowner will qualify for will be calculated by taking the difference between the home’s current market value and what’s left on the homeowner’s mortgage balance.
How Does A Home Equity Loan Work?
A home equity loan works like any other type of secured loan, but the main difference is that it uses your house as collateral. As part of this process, your lender will allow you to borrow a specific amount of money that’s based on the value of your home and you’ll be charged interest and have fixed installment payments to pay it back. In order to qualify, you need to own a house (which needs to be appraised by your lender), have paid off a significant portion of your mortgage and be financially secure enough to handle taking on more debt.
Lenders typically don’t have limitations when it comes to what you do with the money you access through your home’s equity. It can be for necessities like paying an unexpected medical expense, or for things you really want but can’t currently afford like a dream wedding or family vacation. While you technically can use it to finance whatever you like, it’s always advisable to use it for refinancing high-interest debt (so you can get out of debt faster) or for home renovation projects (so you can increase the value of your home) so there’s an actual return on investment.
How To Get A Home Equity Loan?
In order to qualify for a home equity loan, most borrowers will need to meet the following criteria as homeowners:
– You must have at least 20% equity built up in your home
– Your credit score must be 600 or higher
– You must be able to provide verifiable income history for 2+ years
While this criteria isn’t always required and it may be possible to qualify without checking off this list, you can expect to pay a much higher interest rate through a lender that specializes in high-risk borrowers, if that’s the category you may fall into.
Difference Between A HELOC And Home Equity Loan
Both home equity lines of credit (HELOCs) and home equity loans are loans secured by the borrower’s home which means they use that home as collateral. As a result, they typically have much better interest terms than credit cards or personal loans which can make them an extremely attractive option for homeowners in need of cash. While they’re both enticing, it’s important to understand the risks involved, as failure to pay off this debt can result in losing your home instead of just being subjected to interest payments like you would with an overdue credit card.
Home equity loans provide a single lump sum payment which gets paid off over the course of time at a specific fixed interest rate. Both the payment amount and the interest rate will remain the same over the lifetime of the loan but if the home is to be sold, it needs to be paid back in full. As a borrower, you apply for a specific amount that you need and if approved, you receive that amount up front.
A portion of each home equity loan payment goes toward interest and the principal amount of the loan. Typically, the term can be anywhere from 5 – 30 years, but the length must be approved by the lender. Regardless of the period, borrowers will have stable, predictable monthly payments to make for the life of the equity loan. This option can be a better choice financially than a HELOC for borrowers who know exactly how much equity they need to pull out and want the security of a fixed interest rate.
On the other hand, a HELOC is a revolving line of credit that you can borrow from as needed, pay back and then borrow from again based on the term outlined by your lender. It functions like a credit card in how you use and repay funds, but it has a draw period (typically 5 – 10 years) when the loan is open and accessible for use, and a payback period (typically 10 – 20 years) when withdrawals are no longer allowed. HELOCs usually have a variable interest rate and because the amount you’re borrowing is up to you, the payments can vary greatly depending on how the money is used and when.
During the HELOC’s draw period, you will still have to make payments, which are typically interest-only. As a result, the payments during the draw period tend to be small but will become substantially higher over the course of the repayment period because the principal amount borrowed is now included in the payment schedule along with the interest. This transition can be quite a shock to borrowers, so it’s important to prepare for that in advance so you don’t get caught off guard.
If you’re planning to borrow against the equity of your home, learning more about what home equity is and how the process of borrowing against it works is always advisable. If it sounds like this may be good fit for you, make it a point to check on your credit score, create a realistic budget and understand all the costs/requirements associated with choosing to borrow against the equity of your home. It’s always important to consult a professional before you make any big decisions regarding your mortgage, as there are a lot of factors (and costs) to consider. Get in touch with our team to learn more about home equity and how you can put yours to work for you.