A Guide To Home Equity Loans For New Homeowners

Introduction To Home Equity Loan

A home equity loan can be defined as a type of loan that enables homeowners to use their home’s equity to get financing. Equity is the difference between the value of your home and how much you owe on the mortgage. Most homeowners prefer home equity loans to conventional ones as they attract a relatively lower (and fixed) interest rate and are easier to service.

Commonly known as a second mortgage, the home equity loan is taken on top of the primary mortgage; hence no need to alter the original mortgage terms or interest rates. Homeowners that already paid off their mortgage can also apply for this type of loan for up to the home’s total value. If you have been looking to access funding but don’t wish to seek refinancing or sell the house, a home equity loan will prove helpful. 

home equity loan

Home Equity Loan: Definition 

A home equity loan is a type of loan that one can apply against their home equity. This basically is the difference between the value of your home and how much you owe on the mortgage. If your home is valued at $250,000, for example, and you still owe $100,000 in the mortgage, you would have $150,000 home equity. It is, however, worth noting that you can only use your home equity to take a loan/borrow money, not cash-out refinancing.

Although you may not know this, the balance cannot be refinanced, and the interest rate and duration of the mortgage remain unchanged on the primary mortgage. In other words, a home equity loan isn’t tied or added to your primary mortgage, hence the difference in repayment schedule and interest rates. That said, a home equity loan can be referred to as a secondary mortgage. 

 A home equity loan might be what you need when looking to make home upgrades/renovations, pay for your kid’s college, fund a business, or even consolidate debt. It would thus be a bad idea to take a home equity loan to pay for trips, uncertain investments, or expensive purchases that depreciate with time. 

How A Home Equity Loan Works

Once the loan is processed and approved, you will get 100% of the requested amount upfront, which will be repaid monthly in equal installments. 

With a home equity loan, you receive the entire loan amount upfront and repay it in equal installments every month until the total is zero. This type of loan is known as a lump sum installment loan.

Home equity loans are also referred to as lump-sum installment loans. Repayment periods for the loan may vary depending on how much you borrowed, or you can repay monthly, which can be reimbursed within 5 to 30 years. It would only be advisable to apply for long-term home equity loans if planning to improve the current home significantly or wish to buy or build a new home. 

A home equity loan shouldn’t be confused with HELOCs (home equity lines of credit), which allow homeowners to borrow according to their credit lines. It is also very different from cash-out refinancing because you’d have to get a new mortgage for the same. In other words, a home equity loan only allows you to take a second loan against your property, hence a junior lien. Should you choose to sell the home, you’d be required to use the proceeds to settle the unpaid loan. 

Home equity loans are more attractive than conventional loans and credit cards. They attract a relatively lower interest rate compared to personal loans and other lines of credit. It would however be advisable to repay the loan as required to avoid the risk of foreclosure. 

Who Is Eligible For A Home Equity Loan, And By How Much?

Any homeowner is eligible. Nevertheless, you will only be able to access 80% of your home’s value, minus any unpaid mortgage. It is also worth noting that most lenders will only allow amounts not more than 80% of the primary mortgage total.   If your home is valued at $400,000, for example, but with a principal mortgage balance of $150,000, the maximum combined loan amount would total $320,000. With a mortgage balance of $150,000, you could borrow the maximum home equity amount would be $170,000. Other factors, including debt-to-income ratio, interest rate, and credit score, will also be considered when computing your loan margin. 

Requirements For A Home Equity Loan

You need more than home equity to qualify for a home equity loan. Although the requirements will vary from one lender to the next, the most common requirements include the following: 

– 43% or less debt-to-income ratio 

– 20% or more in home equity 

– Minimum credit score allowed by the lender 

– Evidence of capacity to pay or income

Most lenders will allow for the bare minimum credit score for home equity loans. Some lenders will even allow credit scores as low as 620, with most requiring middle or upper 600s. Comparing quotes from different lenders can see you land a better deal too. Homeowners with little to no debt and a sizeable amount of assets can easily qualify for this type of loan. 

How To Apply For A Home Equity Loan

Here are the 7 crucial steps of obtaining a home equity loan: 

1. Review Your Finances 

This ought to be the first thing to do before applying for any loan. Applying for a new loan means your monthly debt would increase. Would your income cover the additional monthly debt without affecting your way of life or ability to service the loans? Be sure to check your credit score and report as well. Most home equity loan providers will need a minimum of 620 on your credit score. Improving the score by paying off credit cards on time, making timely payments, and fixing any discrepancies with your credit report can help. 

2. Determine How Much You Need 

While only the lender can determine how much you’d be able to borrow from them, you still should have a number in mind. You’ll thus need to consider all your financial objectives and how much you can afford per month as repayment to arrive at a reasonable number. You don’t want to borrow more than necessary for that specific purpose. 

3. Get Your Documents Ready 

Prepare any documents the lender may require to process your loan application. These include tax returns reports, bank statements, pay stubs, and w-2s. Most lenders will need these documents to determine your eligibility and how much you’d afford. Preparing these documents in advance will thus improve the chances of the application going through on time. 

4. Compare Several Home Equity Loan Providers 

Every lender will have a specific set of requirements, a reason it would be wise to check with several of them. Comparing different lenders within your locality should also make it easier to identify the most affordable one. The key factors to compare with other lenders include loan terms, prices, credit score requirements, and the maximum amount one can borrow. Be sure to request a quote from your current lender, credit unions, banks, other mortgage firms, and online lenders. 

5. Complete The Underwriting Procedure 

The lender will need to evaluate your eligibility and how much you can borrow before approving your loan. You thus will need to complete the underwriting procedure by submitting bank statements, income statements, debts, and credit history to them. 

6. Wait For Evaluation 

A home appraisal is required to determine the exact value of your house. The lender may thus request an independent assessment before approving your loan application. 

7. Complete The Loan Application

With the appraisal report ready and the underwriting procedure complete, all that remains is your signature to close and complete the application. It is only after signing that the lender can wire a one-time payment for the requested amount. 

On closing, you will be required to repay the home equity loan on top of the regular mortgage. It would be advisable to make regular and timely payments for the same to reduce the risk of foreclosure. You might thus want to schedule automatic payments for the two required payments to be safe. 

Home Equity Loans FAQs

Should I Choose A Home Equity Loan Or A Mortgage?

A home equity loan is a secondary mortgage, with the property used as security. A mortgage, on the other hand, is the loan you use to buy a home, commonly known as the primary mortgage. With your home used as security for equity loans, it would be best to make timely payments for the same to avoid foreclosure. 

How Long Does It Take For A Home Equity Loan To Close? 

Most equity loans take anything between 2 and 6 weeks to close. Although the application criteria may vary from one lender to the other, most lenders look into the availability of appraisers, underwriting procedures, scheduling issues, and delays in document submission when processing a request. These can affect how long it would take for the loan to close. 

What Are The Rates Of A Home Equity Loan? 

Interest rates on home equity loans are a little higher than mortgage loan rates. Their rates are, however, considerably lower compared to credit cards, personal loans, and other unsecured borrowing options. Home equity loan rates are fixed throughout the repayment period. 

Do They Attract Specific Tax Deductions?

Tax deductions apply only for specific applications, such as when using the money to develop, buy, or improve the principal property. There are, however, provisions that will see couples deduct interest on a maximum of $750,000 in mortgage by the end of 2022. Couples can also file interest deductions separately for up to $375,000 mortgage. 

Can Those With Bad Credit Apply For Home Equity Loan?

Most lenders have set a minimum credit score of the upper 600s to qualify for a home equity loan. Individuals with a lower credit score may however be eligible under exceptional circumstances, especially if they don’t have debts or proof of steady income. 

Where Can I Apply?

Credit unions, banks, mortgage firms, and online lenders offer home equity loans. You only need to identify a preferred provider to apply for the loan. Be sure to compare rates and terms with several providers before settling for one.