What is a Home Equity Loan?
A home equity loan (HEL) is a type of loan in which you use the equity of your property, or a portion of the equity thereof, as collateral. Your equity is your property’s value minus the amount of any existing mortgage on the property.
A home equity loan is also commonly referred to as a “second mortgage,” where a “first mortgage” refers to the original mortgage you used to purchase your home. With a first mortgage, the borrower makes monthly payments to the lender, gradually paying off the loan and increasing their equity in a property. With a home equity loan, the lender makes a one-off payment to the borrower, and the borrower’s home equity shrinks. Just like a first mortgage, the borrower must repay the amount loaned, along with additional interest and fees. As the borrower repays the loan, their equity once again increase.
A home equity loan is available to anyone who owns property. It is recommended for financing major one-off expenses, including home renovations or repairs, medical bills, repayment of credit card debt, or funding college tuition.
The main reason to take out a home equity loan is that it offers a cheaper way of borrowing cash than an unsecured personal loan. By using your property as collateral, lenders are willing to take on more risk than if they were only assessing you by your credit score. Other benefits include higher loan amounts and the possibility it offers borrowers with less than average credit of securing a low rate.
Why Take Out a Home Equity Loan?
The main reason to take out a home equity loan is that it offers a cheaper way of borrowing cash than unsecured personal loans. By using your property as collateral, lenders are willing to take on more risk than if they were only assessing you by your credit score, which means larger loans and better interest rates. Another benefit includes the chance it offers borrowers with below-average credit of securing a low rate. It's important to note the risk if you aren't able to make payments--because your home is use as collateral, the lender will own the equity you've used as collateral. This means if you can't pay back your loan, you can lose your home. Choose another option if your income is unstable.
This type of loan is available to anyone who owns their property. It is recommended for financing major one-off expenses, including home renovations or repairs, medical bills, repayment of credit card debt, or funding college tuition.
How Does a Home Equity Loan Work?
Any home owner can apply for a home equity loan. Applying for a home equity loan is similar but easier than applying for a new mortgage.
Each lender will follow roughly the same steps when assessing your application:
1) Financial Information: The lender will ask you for much of the same information as it would when applying for a mortgage—such as access to your credit score and income statements.
2) Home Appraisal: The lender will look closely at the loan-to-value ratio, which is the ratio of equity you have in your own home. It will look closely at the combined loan-to-value ratio – which expresses how much you owe on your first mortgage and home equity loan as a percentage of your home’s appraised value. Some lenders allow homeowners to borrow up to a combined LTV of 80-90%. If your home is appraised at $200,000, you have a loan balance of $150,000 and you take out a $25,000 home equity loan, your LTV would be 87.5% (i.e. $175,000 divided $200,000).
3) Loan Amount: If the lender approves your application, it may offer up to 125% of your home’s value (although the maximum loan-to-equity ratio does vary by lender). For example, if the current value of your home is $200,000 (and you own 100% of the equity in it), then $250,000 is the maximum possible amount you can borrow against your home
4) Tax Deductions: If the home equity loan is being used to build or substantially improve the taxpayer’s home that secures the loan, interest paid to the lender is tax-deductible. If the loan is being used to finance other expenses not related to the existing home, it isn’t tax deductible.
How to Choose the Best Home Equity Lender
As with a regular mortgage, there are many factors to think about when choosing a lender to service your home equity loan
What are the loan limits?
Some lenders have a minimum amount you can borrow for a loan, which can typically vary from around $1,000 to $25,000. With a home equity loan, most lenders won’t agree to anything more than a 90% loan-to-value ratio (and some cap it at 80%). If the principal balance on your first mortgage is 80% of the appraised value of your home and the lender allows a maximum LTV of 90%, this means you’ll only be able to borrow an additional 10% of your home’s value
What interest rate is being offered?
As with any loan, among the first things to check are the interest rate and APR. Home equity loans usually come with a fixed interest rate, meaning the rate stays the same over the entire term. Home equity lines of credit come with an adjustable rate, meaning the rate can fluctuate over time. If your LTV exceeds 80%, this may result in the lender charging a higher rate
What additional fees are there?
Like with a first mortgage, the closing fees can vary by lender but they typically include lender fees like application fee, origination fee, and underwriting fee, as well as third-party fees like appraisal, surveying, title search, and taxes. You may be able to negotiate having the lender waive some or all of these fees. For example, some lenders have shown themselves willing to waive surveyor or valuation fees if the borrower arranges for their own licensed surveyor or appraiser to inspect the property.
How long does the application process take and what documentation will the lender ask for?
A lengthy application process can be almost as damaging as a high interest rate, but unfortunately this is one factor borrowers often overlook when shopping around between lenders. Just like with a first mortgage, it can take anything from a couple of weeks to a couple of months to close a home equity loan. If you’re planning to use the funds from your home equity loan to pay for a much-needed home improvement or eliminate credit card debt, delays could prove costly
How trustworthy is the lender and what level of customer service does it offer?
As with any financial product that involves large amounts of money, it’s important to check how trustworthy your provider is before signing a contract. When checking out a lender, make sure to read online reviews and customer feedback and to have a set of questions ready for your first phone call with a loan agent.
Best Lenders for Home Equity Loans
The following 3 lenders offer some of the best home equity loan rates and terms on the market, as well as the best home equity line of credit loans:
- Get quotes from multiple lenders in seconds
- Use free tools to check what you can afford
- Minimum credit score, max LTV, max debt-to-income vary by loan
LendingTree is an online marketplace that connects borrowers with the lowest rates on mortgages, refis, and home equity loans from its network of top lenders. To compare between different lenders, just fill in a few details about the HEL you’re looking for, including home value and loan amount, and LendingTree will let you compare different loans side by side
LendingTree’s service is completely free to use. Once you’ve scanned through the various loan options and received pre-approval, LendingTree will share your contact details with the relevant lenders. These lenders will get in touch with you directly and provide further detail about how to apply for your loan
Standout Feature: Entire service is free of charge
- Direct lender with 100% online platform
- Reputation for strong customer service
- Credit score and debt-to-income requirements vary by loan
J.G. Wentworth is a customer-focused direct lender that enables customers to conduct their entire application online. It offers cash-out refinancing, an alternative type of home equity loan in which the borrower refinances and cashes out the difference between their old and new mortgage.
J.G. Wentworth has been doing business since the 90s, but the online portal shows it’s up to date . Customers can fill out all their paperwork online and can even submit documents with an e-signature, avoiding the need to visit one of J.G. Wentworth’s physical locations.
Standout Feature: Everything can be done through the online portal
- Quicken Loans’ online and mobile platform
- Streamlined application process with minimal documentation
- Credit score and debt-to-income requirements vary by loan
Rocket Mortgage is Quicken Loans’ online and mobile offering. Like Quicken, Rocket also offers cash-out refinancing, an alternative to a home equity loan in which the borrower refinances and receives the difference between their old and new mortgage in cash. Unlike Quicken, Rocket offers its customers the opportunity to go through the entire application process online
Applying for a cash-out refinance or other loan via Rocket Mortgage is straightforward. The automated platform helps cut down on unnecessary waiting time, requires minimal documentation and provides real-time updates on your application process
Standout Feature: Complete the entire process quickly
Costs of Home Equity Loans
Just like mortgages, home equity loans typically include closing costs of around 2-5% of the value of the loan. Lenders are often open to negotiation on these closing costs, making it worthwhile to shop around between at least 3-4 lenders when thinking about applying for a home equity loan.
Typical closing costs include:
Application or origination fee: This fee is sometimes waived, depending on the lender. Be sure to ask if the lender you are interested in requires an application or origination payment at the start of your loan application or upon receipt of funding.
Title search: You will need to prove to your potential lender that you are the rightful owner of the home you are interested in borrowing against. This can be up to around $1000, or as low as a couple hundred.
3rd-party appraisal: This fee varies depending on how thorough an appraisal your lender wants. A simple home appraisal based on a checklist of factors can be as low as $150, and a more complex appraisal can cost over $1000.
Credit report fee: Credit checks can cost around $50.
Attorney or notary signing services: Hiring an attorney or notary to whitness signing your loan documentation can cost around $100.
Government taxes: Many lenders require proof that you're up to date on your property taxes, which varies in cost. It tends to be an inexpensive part of the application provess if you are up to date: around $10.
Annual maintenance fee: You may be required to pay an annual fee for time you have the home equity loan. This is most commonly the case for home equity lines of credit, and can be 3-6% of your loan.
Home Equity Loan vs Line of Credit
| ||Home Equity Loans||Home Equity Line of Credit|
|Fixed interest rates||Yes||Yes|
|Variable interest rates||No||Yes|
|Lump sum disbursement||Yes||No|
|Funds as needed||No||Yes|
|Use home as collateral||Yes||Yes|
A home equity loan and home equity line of credit (HELOC) are both types of second mortgages, but they offer different pros and cons. Home equity loans are the more conservative option for borrowers, offering a lump sum and fixed interest rate for payments. Lines of credit act more like credit cards, allowing homeowners to borrow against their home equity at a variable rate and to draw the money as needed. A home equity line of credit offers more flexibility and more risk than a home equity loan.
Home Equity Loan vs Refinancing
A cash-out refinance has 2 functions: it can be used to lower the interest rate on your mortgage, and to simultaneously borrow a large sum from the equity you’ve built up. It’s only a better option than a home equity loan if you need money and have improved your credit score or financial position to the point where you can now qualify for much better mortgage terms.
Can I Get a Home Equity Loan with Bad Credit?
Exact rules vary by lender, but most are willing to offer a home equity loan to homeowners with a credit score of as low as 620, and some do accept as low as 580. Because the borrower’s home is being used as security, lenders will typically offer favorable terms on a home equity loan. This can include low interest rates, a higher maximum amount on the loan, and willingness to overlook a poor credit score. Of course, the poorer your credit, the more likely the lender will offer you a worse interest rate on your loan.
Alternatives to Home Equity Loans
In addition to a HELOC or cash-out refinancing, there a number of other alternatives to home equity loans:
An Unsecured Personal Loan
A type of loan that doesn’t require you to put up your home or anything else as collateral. When you put up your home or other asset as collateral, you give the lender the authorization to claim your home if you fail to make payments. If you’re not feeling confident about making payments, a personal loan offers a way of borrowing at only a slightly higher interest rate but with less risks attached
Credit Card Advances
A quick and easy way of getting money at rates close to 0. The risk with a credit card advance is that the rate can go up to 20% or more at the end of the 6-12 month introductory period. Therefore, a cash advance is only a good alternative to a home equity loan if you don’t need a large amount of money and are confident you can pay it back before the introductory period expires
If you’re aged 62 or more and own your own home, then you’re eligible to take out a Home Equity Conversion Mortgage, a type of reverse mortgage guaranteed by the Federal Housing Administration (FHA) in which the home owner borrows a portion of their home’s equity. After a reverse mortgage has been approved, the borrowers must use the property as their primary residence for the duration of the loan, and they remain responsible for paying property taxes and insurance and for fulfilling any other FHA guidelines.