All You Need To Know About Home Equity Loans

Nathan J. Lee - 2020-06-11T21:00:00.000Z

If you are a homeowner and need cash in a hurry for one reason or another, a home equity loan can help. They make for a convenient, low-cost method to borrow a larger amount at better interest rates compared to unsecured personal credit agreements.

In this article we will take a close look at home equity loans (HEL) and how they differ from a home equity line of credit (HELOC) to help you determine the most appropriate option for your circumstances.

What Is A HEL?

So, exactly what is a home equity loan?

Simply put:

Borrowers receive funds by using their property as collateral.
Based on the value of the home, they can borrow a lump sum amount.
The loan appraiser calculates the qualifying amount based on current equity.

Home equity loan rates are both fixed and adjustable with a set duration, which is usually between five and 30 years. There will be closing costs, but usually less than the amount you would pay on a full mortgage.

Although you may see it as an attractive option, even some of the best home equity loans have disadvantages:

You need to put your house as collateral and at risk of repossession.
If the value of your house declines, you will owe more than it is actually worth.
You need to pay a termination fee if you repay early.

What About HELOC?

A HELOC allows borrowers to access funds from a revolving credit line determined by the lender. Just like a credit card, you can borrow money for the lifetime of the loan based on the equity of your house and the credit limit.

You need not borrow the full amount of the loan, and the limit replenishes when you repay the borrowed amount. You can continue to borrow, use, repay, and borrow again. The period for borrowing can be up to 10 years, and the repayment period between 10 and 20 years.

You also only need to pay interest on the borrowed amount and not the entire line of credit. However, it does have disadvantages:

Just like a HEL, you are placing your home at risk of repossession.
There is always a chance of borrowers accumulating further debts because of revolving lines of credit.
Variable interest rates bring in an element of uncertainty in the amount you need to repay.

Which One Is Best?

Home Equity Loans - These are ideal for borrowers who need to finance a major expense, like house renovations. You should not use them to borrow a smaller amount. $10,000 is the minimum sum you need to borrow, so look for other options if the sum you require is less.
Home Equity Lines Of Credit - An ideal option for borrowers who have varied requirements in terms of the loan amount. For example, you might need to borrow to start your own business or fund an academic course. You do not need the best credit scores to qualify for a loan. Still, keep in mind that poor scores would mean you will have to repay at higher rates.

How To Apply For A HEL?

There are certain important things to keep in mind before you apply for a HEL:

Calculate Your Equity - The amount you can qualify for depends on your equity in the property. You can calculate this by determining the value of your house and deducting the money you owe on it.
Check Your Score - If your score is good, it is generally easier to qualify for a loan. Check your credit report before you apply. If you are hoping for the best home equity loan interest rates, consider doing everything to improve your score first.
Know Your Debts - The chances of qualifying will also depend on your debt-to-income ratio. A higher DTI ratio will hamper your qualification for a loan.
Do Your Research - The qualification criteria, interest rate, and repayment term differ for each lender. It is important to look around for different options and compare them before deciding.
Keep Important Information Handy - Application and qualification is a lengthy process which you can speed up by keeping all your important documents in place. Gather your tax returns, pay stubs, etc. when applying for a loan.

Conclusion

Having equity alone does not make you eligible for a loan. Though the process is more lenient compared to the original mortgage, you still need a stable income, good credit score, and a debt-to-income ratio on the lower side.

Consider the advantages and disadvantages thoroughly before deciding. Even if you qualify for a higher amount, borrow only what you require.