What Is A Home Equity Loan?

09.15.2020 | Category: Homebuying

Owning a home is a major milestone in a person’s life. In many areas of the U.S., home values have increased considerably in recent years. For many homeowners who encounter unexpected bills or expenses, a home equity loan can be an effective way to pay ease financial struggle, consolidate debt and access cash quickly when emergencies arise. Using money received from a home equity loan responsibility can help a homeowner improve their overall financial situation.

A home equity loan is also known as a second mortgage. This type of loan allows a homeowner to borrow against the equity in their current home. The new mortgage is secured by the value of the property. Typically, home equity loans can offer lower interest rates and higher loan limits to borrowers because it is safer for banks to lend money that is secured. A home equity loan and a home equity line of credit (HELOC) although similar, are not the same thing. Unlike a HELOC, which has payments and interest rates that will vary based on the amount that is borrowed, a home equity loan is traditionally based on a fixed amount, for a fixed time, with a fixed rate of interest, and predictable regular monthly payments.

How Does a Home Equity Loan Work?

A homeowner has tappable equity in their home if the property’s market value is higher than the balance on the owner’s mortgage. A bank or lender typically can approve a home equity loan up to 80% of a property’s current value. To calculate a home’s equity, a borrower can take the total of the amount they still owe on their current mortgage plus any other debts secured by that property and subtract that from the current market value of the property. Once approved for a home equity loan, a lender will pay out a single lump sum to the homeowner. Upon disbursement of the loan funds, the homeowner will be required to pay a set amount every month for the term of the loan. Typically, loan terms for a home equity loan range from five to fifteen years.

What Are The Benefits Of a Home Equity Loan:

There are many benefits homeowners can enjoy from responsibility using a home equity loan.

Access & Eligibility: Another benefit of a home equity loan is the lower required threshold for a borrower’s credit score. Because the home is acting as collateral, home equity secured loans can be easier to obtain with credit scores as low as 620.

Lower Interest-Rate: Usually, home equity loans have an affordable and manageable interest rate. If a consumer is struggling to make a dent in lowering their high-interest credit card debt, a home equity loan can be used to pay off those balances, often at a lower interest rate. Many homeowners who use a home equity loan enjoy the stability using a loan with a fixed term and interest rate to consolidate debt or better manage other large expenses.

Predictability: Unlike personal loans or other unsecured debt, home equity loans are stable and predictable because of their typical length and term requirements. Once approved, a homeowner can prepare for monthly expenses without the concern that these fees will suddenly or dramatically increase.

Tax Incentives: If a homeowner uses the funds from their home equity loan towards home improvements, they will likely be able to deduct the mortgage interest of the loan on their taxes. In order to qualify for this benefit under the 2017 Tax Cuts and Jobs Act, a homeowner must use the funds from a home equity loan for capital improvements, such as to “buy, build or substantially improve” the home that secures the loan. This is not intended as tax advice. Please consult a tax specialist.

What Is Needed To Get a Home Equity Loan?

Similar to other mortgage loans, in order to get a home equity loan a homeowner will need to complete an application and review process. After a thorough assessment of key factors, a lender can evaluate how much a homeowner can borrow from their home’s equity. Most lenders will consider the following criteria during the application process for a home equity loan.

1. Current Equity: Most lenders will not lend over 80% of a home’s equity.
2. Income: A lender will confirm your employment and verify that you have the ability to pay back the loan and use a calculation of your income as part of this consideration.
3. Outstanding Debt: A homeowner’s debt-to-income ratio will often be reviewed by the lender and used in the assessment of their eligibility. Most lenders require a borrower’s debt not to exceed 43% of their monthly income.
4. Credit Score: Although the minimum credit score requirements are lower for a home equity loan than other mortgage loans, a lender will use a borrower’s credit score to better understand their credit-worthiness including their payment history and revolving debt.
5. Appraisal: Depending on the lender, if a homeowner is applying for a home equity loan of more than $250,000, an additional appraisal to confirm home valuation may be required.

How Long Does A Home Equity Loan Approval Take

After successfully submitting a lender’s application and providing the required documentation, a process will confirm the completeness of a home equity loan and then the files will be passed to underwriting for thorough review. The total process for a home equity loan could typically takes an average of 30 to 45 days, depending on verification of appraisals and government requirements.

Can You Use A Home Equity Loan For Anything?

Most often, homeowners who secure a home equity loan use the funds towards the following types of expenses: home improvements, debt consolidation, college costs, emergency expenses, wedding costs and long term investments. Although there are no restrictions on how the liquid assets from a home equity loan can be used, many lenders will discourage homeowners from tapping their home’s equity for unnecessary personal expenses or extravagant expenses such a luxurious vacation, expensive new boat or an over-the-top luxury vehicle.

How Many Home Equity Loans Can A Borrower Have?

A homeowner is able to be approved for as many equity loans or mortgages as they are financially eligible for as per a lender’s review. Essentially, as long as a homeowner is not overleveraged or owes more on their property than it is worth, there is no set amount that limits the number of active equity loans one person can have at any given time.