Homeowners looking to capitalize on their homes’ equity may find it a little easier to get a home equity loan or line of credit (HELOC) compared to last year. In the midst of the COVID-19 pandemic, many banks in the US announced that they were no longer offering home equity products. But that is changing with soaring property prices across the country.
“Even though interest rates were low during the pandemic, getting a home equity loan was a challenge as lenders made income and property qualifications more stringent,” said Fred Glick, CEO of Arrivva, a real estate company. “It’s getting better now.”
If you are interested in a home equity loan or HELOC, make sure that you have equity in your home, your loan is in good condition, and you are ready to pay back the loan.
While the names are similar, home equity loans and HELOCs are different financial products. Although they both use your home as collateral, deciding between the two options will depend on how you plan to use the funds.
Before taking out a home loan, it is important to understand some of the pros and cons. Read on to find out more.
What is a Home Equity Loan and Home Equity Line of Credit (HELOC)?
While both are similar, there are some differences. Remember, both of these can put you at risk of foreclosure if you fail to repay your lender.
Home loans are paid out as a one-time lump sum that you repay to the lender with fixed monthly rates of interest. Think of it like a second mortgage on your home. Home loans have fixed interest rates, which means the interest rate does not change. They can also be tax deductible depending on how you use them.
A HELOC acts like a credit card so you can access the money when you need it. When you pay back the balance, the available balance will be replenished. There is a draw period when you can withdraw funds followed by a repayment period when you will no longer have access to the funds.
Requirements for borrowing funds
To borrow money from your home’s equity, you need to have enough equity in your home. To qualify, you should already have deposited at least 15-20% of the value of your home – for example, $ 100,000 if your home is worth $ 500,000. Part of this process will be the lender evaluating the value of your home, which will be at your expense.
“Equity is the difference between the appraisal of your home and your total mortgage balance,” says Samuel Eberts, junior partner and financial advisor at Dugan Brown, a pension fund.
Lenders also take a look at your debt-to-income ratio (DTI), which is calculated by dividing total monthly debt payments by gross monthly income. Qualified DTIs vary from lender to lender, but it’s typically less than 36%, which means your debt should be less than 36% of your gross monthly income. Other lenders go up to 50%. Lenders will also look at the loan history. A credit score over 700 is good enough to be accepted; a credit score in the mid-600s can be accepted. Good credit is important as it will help you get a better interest rate.
To prove that you have income, present pay slips and possibly W2s and tax returns.
Should You Get a Home Equity Loan or HELOC?
Before deciding between a home equity loan and a HELOC, it is important to know how much money you will need for how long.
“If you are not sure how much money you will need for what you want to achieve, take the line of credit [HELOC] offers more flexibility than the loan. The downside is that interest rates can go up and you can get stuck paying the interest while making your regular mortgage payment, ”says Eberts.
Whichever you choose, you pay. Since your home is used as collateral, you don’t want to run the risk of foreclosure.
Alternatives to home equity loans and HELOCs
If the idea of using your home as collateral for a loan doesn’t appeal to you, there are other ways you can achieve your financial goals. Here are some other options:
- Cash-out refinancing: A cash-out refinance is when you refinance your home mortgage for more than you owe and receive the difference in one flat rate. “If you are eligible for lower rates with a cash-out financial plan, this can be a great idea,” said Akhil Kumar, vice president and CCO of Arch Global Advisors, a financial advisory firm.
- Prepaid Credit Card: If you have a good credit score, you can qualify for a Prepaid 0% APR card. It gives you the option of transferring debt to a 0% interest card, sometimes for 18 months. This gives you the opportunity to make a big purchase and pay it off over time with no interest. Be sure to pay it off by the end of the promotional period or you will pay interest on the remaining balance.
- Loan Advice: If you’re struggling to keep your budget and pay off your debts, or if you have a financial goal to build on, you can reach out to a nonprofit credit counseling agency to help. You get education-based tools to help you manage your money. It allows you to take control of your own financial health and helps you make better decisions in the future. Find a loan advisor by searching the US Trustee Program database here.
Frequently asked questions about requirements
Can I get a home loan without a job?
It’s unlikely. Lenders will be careful about how you can repay the loan. “But just because someone doesn’t have a job doesn’t mean they don’t have an income. Inactive sources of income that may allow you to take out a loan include pensions, social security pension benefits, disability payments, and investment income, ”says Eberts.
Are There Any Limitations On Using Funds From A Home Loan?
Funds acquired from a home equity loan or HELOC can be used for almost any purpose, such as: For example, to buy a new car, finance a child’s education or take a vacation. The funds can also be used to renovate the main residence.
How much does it cost to take out a home equity loan or HELOC?
The average closing costs are usually 2 to 5% of the total loan amount or the line of credit. Sometimes a lender can offer toll-free HELOCs or home equity loans; However, they may already have added it to the interest cost of your loan, so always double-check if you are not sure. Closing costs include lender fees and third party services and include things like appraisals, title insurance and settlement fees, among others.
Can I shop at better conditions and lower closing costs?
Certainly. “It’s best to look around and compare lenders and things like terms and prices,” says Kumar. “Also, if you refinance, your closing costs will often be lower.” Finally, before you apply for home equity financing, you can qualify for better terms, including lower closing costs, as you work to improve your creditworthiness. Overall, it is always in your best interests to research the options available before deciding which one is best for you and your family.