Home Equity Loans

    Find out how tapping into the equity in your house can open the door to a lot of financial possibilities that you didn’t think you could afford.



    Man filling out paperwork - Home Equity Loan

    Need some extra cash? Home equity loans are a convenient way to borrow large sums at favorable rates. What’s not to love about that?

    The “equity’’ figure is a simple math equation: Home’s value minus amount owed = home equity.

    So, if your home is worth $200,000 and you owe $125,000, you have $75,000 worth of home equity.

    Most lenders offer an 80% loan-to-value rate based on your equity. With the $75,000 equity example, you could qualify for up to a $60,000 loan ($75,000 x .80 = $60,000).

    You would receive the $60,000 in a lump sum, then begin a monthly repayment schedule at a fixed rate.

    And now that often-asked question: Can I get a home equity loan for anything?

    The answer is … YES! Anything your heart desires. Lenders won’t follow you around to see how the money is spent.

    If you qualify for a home equity loan, the cash can be used for financing your daughter’s wedding, taking a family vacation to Europe, getting some front-row Broadway tickets to “Hamilton,’’ purchasing season passes for your favorite sports teams, paying off your student loan or even making home improvements.

    The lender really doesn’t care because there is a huge piece of collateral – your house! – backing the loan. As long as you complete your payments on time, it’s simply another successful transaction.

    Home Equity Loans and HELOCs Not the Same Thing

    It’s important to distinguish between home equity loans and home equity lines of credit (HELOCs).

    The home equity loan is a lump sum money given to the qualified homeowner. It is repaid over time with fixed monthly payments. Each payment reduces the loan balance and covers interest costs on a familiar amortization schedule.

    With a HELOC, you receive a line of credit for an approved amount and borrow against that amount as needed. You can withdraw from the line of credit multiple times and make smaller payments for several years before a fully amortized schedule kicks in.

    HELOCs are flexible. You pay interest only on the amount of money that is drawn out. The interest rates are variable, so the costs can change over time. Another factor: The lender can cancel the line of credit, possibly before you’ve had a chance to use that money, so there is some risk.

    How Do You Qualify?

    Home equity loans operate much like a mortgage or auto loan. The borrower receives a lump sum of money that is paid back over a fixed time with a fixed interest rate. In 2017, the rates were averaging about 5% with some available for close to 3%.

    The terms are pretty standard, ranging from 15 to 30 years, although some lenders are flexible and will approve a home equity loan for five years.

    Approval, by the way, is not guaranteed.

    Banks are much more careful after the 2008 housing crisis, when it was more of a rubber-stamp operation. Lenders evaluate your application and generally make sure the 80% loan-to-value ratio isn’t surpassed.

    Basically, like most loans, home equity approval moves forward if you demonstrate the ability to repay. The ability to repay is an amazing thing. Lenders go through credit reports to verify your finances. You need to provide proof of income with pay stubs, tax returns, investments, etc. Your credit will be checked carefully. An appraisal will be required. The whole process will take several weeks (maybe months) before any money is released.

    It’s similar to applying for a home purchase loan. Another similarity: You should shop around with banks, credit unions and online lenders because interest rates can vary.

    Lenders don’t want risk. Neither should you. A home equity loan is a secured loan, meaning your home is technically at risk because it’s the loan collateral. If something drastic occurs such as a job loss or serious medical condition, and you can’t make payments, your home could go into foreclosure.

    If you are hesitant because of volatility in the real-estate market, it could be very difficult to sell your home. You might investigate other options, such as mortgage modifications.

    Make sure you know exactly what you’re getting into. Sometimes, your financial needs can be solved with a zero-interest credit card or personal loan, options that don’t involve putting your home at risk. If you take the home equity loan, it helps to have a detailed list of income and expenses, so you can see how to manage a hefty new payment.

    If you are approved easily, don’t be swayed by the quick access to large funds. Your home is not an ATM complete with couches and tables.

    The prudent steps are to use your home’s equity for things that improve its value, add practical significance to your life or put your family in position for a better financial future.

    Beware of the scammers, too. Like anything these days, the world is filled with opportunists who try to cheat homeowners. If there’s a high-pressure sales pitch or the inability to put things in writing, don’t accept those tactics. The stakes are too high to fall for a con artist.

    What Documents Are Needed?

    Getting a home equity loan is a thorough process. You’ll need to pull together the following information and documents:
    • Property information (address, purchase price, purchase date, property type).
    • Estimated property value.
    • Personal information (Social Security number, date of birth, marital status, employment status, residential status).
    • Employment and income information.
    • Debts such as auto loans, student loans, credit cards, current mortgage and home equity accounts.
    • A completed and signed Internal Revenue Service (IRS) Form 4506T.
    • Copy of your most recent pay stub that reflects earnings for the past month and year to date.
    • The most recent two years of W-2 forms from your employer.
    • Self-employed borrowers will need the most recent two years of personal IRS tax return documents (and all schedules), the most recent two years K-1’s from the partnership, LLC or S Corporation.
    • Proof of homeowners, hazard and flood insurance.

    Is There A Minimum?

    Generally, home equity loans don’t dip below $10,000. Most lenders won’t bother with loans less than that. Some banks have a $25,000 minimum.

    Home Equity Loan With Bad Credit?

    Lenders are looking for good to excellent credit when considering a home equity loan. You can find some with credit scores in the 620 range, but that’s pushing it.

    Of course, every situation is different. Home equity loans could become available for borrowers who have lots of equity or a low debt-to-income ratio.

    There are also scenarios where it pays to do whatever it takes to boost your credit score in the short term — whether it’s opening a secured credit card, clearing up your collection history and getting on a schedule to avoid late payments — so you can qualify for the home equity loan.

    Home Equity With Va Loan?

    It’s possible to get a home equity loan with a home that was purchased through a VA loan. However, it’s probably more efficient to pull cash equity from your home through a newly financed VA loan. That’s a technique known as “cash-out refinancing.’’

    Cash-out Refinancing

    And speaking of cash-out refinancing, that’s a topic worth addressing for all borrowers, not just those with VA loans.

    The questions: Am I better off getting a second mortgage in the form of a home equity loan? Or I should get an entirely new mortgage, then take some money out of that?

    Both options will give the borrow access to funds that can be used for medical emergencies, major home repair or straightening out other financial maladies such as student loans or credit card debt.

    But there certainly are differences:

    If a borrower opts for a home equity loan for, let’s say, $100,000, they will receive a lump-sum figure, then have monthly payments at a fixed rate. And they still will have the remainder of their old mortgage.

    If a borrower opts for a cash-out refinance, they are essentially refinancing their current mortgage for more than what they currently so they can receive extra funds.

    Example: The borrower owns a home worth $200,000 and owes $100,000 on their mortgage at a high interest rate, but they can refinance at a lower interest rate while taking out a larger mortgage. They refinance the mortgage at $130,000, replacing the $100,000 of the old mortgage, while receiving $30,000 in cash.

    The cash-out refinance replaces the current mortgage. Even though there’s additional cash received, there’s only one monthly payment. The approval process for a cash-out refinance can be cumbersome and time-consuming, but the borrower will receive a lower interest rate, a fixed payment and access to additional cash.

    In some cases, it might be a better option than a home equity loan.

    Pros and Cons

    Before deciding upon a home equity loan, consider the advantages and disadvantages.

    Pros
    • Rates Are Lower: With your home serving as collateral, you won’t pay as much interest as an unsecured loan with no collateral.
    • Tax Benefits: By itemizing your deductions, the interest from the first $100,000 of your loan is tax deductible.
    • Large Funds: Home equity loans probably provide more funds than any other source, including personal loans and credit cards.
    • Flexibility: Whether it’s a need (home repairs) or a want (lavish vacation), home equity loans can be used for any purpose.
    Cons
    • Risk: Your home is the collateral. Worst-case scenario, if you suddenly can’t repay the loan, your lender can take your home.
    • Going Underwater: If you tap into your home’s equity, then its value declines, you could owe more on your home than it’s actually worth. The well-known terms are being “underwater’’ or “upside down’’ on your mortgage. It was a common occurrence during the 2008 subprime mortgage crisis and standards have changed. But it’s still a possibility, so be wary.
    • Closing Costs and Fees: Home equity loans can serve as a second mortgage. So just like your primary mortgage, the closing costs (perhaps up to 6% of the loan) can be expensive. There may also be an early termination fee if you pay off the loan ahead of schedule.
    • Taking on Debt: Sometimes, it’s necessary. And it’s a way to pay for some essential items with relatively favorable interest rates. But it’s still debt.

    If you’re using the money from a home equity loan for things you truly don’t need, consider this: You are taking a chunk of your net worth and converting it into debt.

    Fundamentally, it’s just not a wise move.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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