Your home can be used as collateral to borrow money through a home equity loan. You’ll receive a lump-sum payment and repay the loan at a fixed interest rate.
Home equity loans let you borrow against the value of your house. The downside of an equity loan is that it is secured by your home, so failure to repay it could lead to foreclosure. Here’s what you need to know before taking out a home equity loan.
So, What Exactly is a Home Equity Loan?
Home equity loans allow you to borrow cash as a lump-sum payment and repay it at a fixed interest rate, but only if you have adequate equity available.
A homeowner’s equity is the difference between the value of their home and their mortgage balance. You can grow your home equity by steadily paying down your mortgage. If property values in your area rise, your equity could grow rapidly.
How Does A Home Equity Loan Work?
When borrowing a home equity loan, it may be appropriate to borrow money if you know exactly when and how much you need – for instance, when financing a home improvement project.
The home equity loan is repaid monthly, both interest and principal, at a fixed rate over a specified time period. If you plan on taking out a second mortgage with your current one, make sure you can afford it along with your other monthly expenses.
How Much Does A Home Equity Loan Allow You To Borrow?
Home equity loans usually allow you to borrow 80% to 85% of the value of your home, less the amount you owe on your mortgage. Estimate your borrowing capacity with some simple math.
Say you own a $350,000 house, have a $200,000 mortgage balance, and your lender allows you to borrow up to 85% of the house’s value. Take the value of your home ($350,000) and multiply it by the percentage you can borrow (85%). The maximum value you can borrow will be $297,500. The amount you can borrow as a home equity loan will be approximately $97,500 once you subtract the amount remaining on your mortgage ($200,000).
Requirements For Home Equity Loans
Depending on the lender, home equity loan qualification requirements will vary, but here are some general guidelines:
- You should have a minimum of 15%- 20% home equity.
- Credit scores of 620 or higher are required.
- 43% or lower debt-to-income ratio.
To determine how much you can borrow, your lender may also require an appraisal for your home’s fair market value.
Is It A Good Idea To Take Out A Home Equity Loan?
The decision to take out a home equity loan depends on your financial situation. Considering the risk, you should carefully weigh the pros and cons of using your home as collateral.
- Payments at fixed rates are predictable, which simplifies budgeting.
- Low interest rates compared to personal loans and credit cards.
- There is no need to give up a low mortgage rate.
- Your interest may be deducted if the loan is used for home improvements.
- Not as flexible as a home equity line of credit.
- Even if you use your loan incrementally, like when remodeling, you’ll still have to pay interest.
- You risk losing your home if you miss or delay payments.
- Your home equity loan balance will be due if you sell your home before paying back the loan.
While most people understand mortgages, a sizable number aren’t sure what to look for while taking out a home loan. Knowing about these key considerations when taking out a home loan is crucial.