With a home loan or line of credit, you can borrow money against the value of your home and use it for home improvement projects, college tuition, paying off higher-interest debt, or just about anything.
But when can you get a home loan or line of credit? And how much can you actually borrow?
As with any large movement of money, there are pros, cons, and risks. It’s important to remember that both a home equity loan and a home equity line of credit are secured loans that your home is the collateral for – meaning the lender can take over your home if you are disagreed with the repayment.
But depending on your circumstances, a home equity loan or a home equity line of credit (HELOC) can be an option to get the value of your home.
How Much Can You Raise With a Home Equity Loan or HELOC?
Home loans and HELOCs work similarly but are two very different things.
A home equity loan is a loan against the value of your home that is paid to you in a lump sum. In this sense, it is like a mortgage that you have to repay in installments with principal and interest.
On the other hand, a HELOC is a predetermined amount of credit, much like a credit card works. They’re a revolving line of credit, which means that if you have a HELOC of up to $ 30,000 and want to renovate your garage for $ 10,000, you still have $ 20,000 left to use at a later date – or not.
Pro tip
Don’t take the first offer you get – shop with different lenders to get the best price.
HELOCs usually have a term of around 25 years and are divided into a drawing and a repayment period. The former is the time that you can draw the line of credit and only pay interest on the amount drawn. The latter is when you repay the principal as well as the interest.
A home equity line of credit may allow you to borrow up to 85% of the appraised value of your home minus the amount you owe on your first mortgage. A home loan allows you to borrow up to 85% of the equity in your home, depending on your credit and how much other debts you have.
For example, if you own a $ 300,000 home and your mortgage owes $ 150,000, you can open a line of home equity for $ 127,500 or get a home loan for $ 105,000. Here’s a simple example of how it composes with a sample 5% interest rate, which is currently some of the best HELOC or home equity loan rates available:
| Home equity | Amount owed on mortgage | Maximum loan amount | Interest Paid | |
|---|---|---|---|---|
| Home loan | $ 300,000 | $ 150,000 | $ 105,000 | $ 5,250 |
| Line of credit for home equity loans | $ 300,000 | $ 150,000 | $ 127,500 | $ 6,375 * |
Note: Most HELOC rates are variable and you only pay interest on the money you actually use which increases or decreases over time.
Just because you might be eligible for the maximum amount doesn’t mean you have to sign that amount – you should get a home equity loan, or HELOC, that suits your financial goals.
When and where can you tap your home equity
In order to be approved for a home equity loan or HELOC, you must demonstrate that you have significant equity in your home. Most lenders require that you have at least 15 to 20% equity in your home after the loan or HELOC is granted, says Elliot Pepper, CPA, CFP, and co-founder of Northbrook Financial.
For example, if you own a home worth $ 500,000 and owe $ 250,000 on a mortgage, you have 50% equity in your home and can get a loan or HELOC up to $ 150,000 depending on your credit. This, in turn, would reduce your equity, but still keep it at 20%. They owe $ 400,000 to a $ 500,000 home, Pepper explains.
While you can technically get a home loan or HELOC once you own a home, it usually takes some time to build up the equity required. If you’re thinking about one, the best time to do it is when you have cash flow, little or no consumer debt, stable employment, and good credit, with a score of 720 or higher for the best interest rate, says Lindsay Martinez. Owner and financial planner of Xennial Planning LLC, a financial planning company.
You should also familiarize yourself with the “loan-to-value ratio,” which is simply the size of the loan in relation to the value of the property. To calculate it, divide the total mortgage amount by the property’s appraisal. The lower your rate, the lower the interest rate can be, all other factors being equal – this is because the lender considers borrowers with a lower rate to be less risky. You can get the best prices when the ratio, often referred to as the LTV ratio, is below 80%.
Whether you’re looking for a home equity loan or a HELOC loan, checking with your bank is a good place to start.
“Most major banks and financial institutions offer home equity loans, so it is always a good idea to get a few quotes and compare terms, particularly the interest rate and other fees, to make sure you are getting the right loan for you,” Pepper told us earlier this month.
You don’t have to get a home equity product from your original lender, however; You can search for the best interest rate, lowest closing cost, and shortest time to close. Martinez also suggests asking a prospective lender to meet or beat someone else’s terms.
Since both home equity loans and HELOCs require you to use your home as collateral on the loan, keep in mind that if you cannot repay it, you could lose it. So make sure you only apply if you have a solid plan for how the money will be used.
“You shouldn’t be taking out a home loan for personal expenses like a boat or a fancy vacation,” Martinez told us. You should only use home equity loans or lines of credit to fund expenses that result in long-term gains; This includes home improvement, college tuition, and even paying back higher-interest debts such as credit cards.
Checklist: What You Need For Your Home Equity
Once you’ve decided that home borrowing makes sense for you, it is time to get your records in order. Before you go to a bank of your choice and ask them for a loan or line of credit, you should have the following on hand:
- Personal data about you and all co-borrowers (social security number, date of birth, marital status, employment status, residence status)
- Information about your home, including purchase price and date, property type, estimate of your property value
- Information on all of your debts and payment obligations. These include mortgages on the property, car and student loans, and credit card debt
- Employment biography and current income
Before getting into the process, make sure that you have a credit score of at least 620 (or 720 for the best interest rate) and that your debt-to-income ratio is 43% or less. This may mean waiting for you to improve your credit score and / or reduce your debt in relation to your income. For example, early payments on credit card balances are a way to improve your score in the short term.
Bottom line
Home loans and home equity lines are a great way to unlock the value of the greatest asset you are likely to own.
By borrowing money for your home, you can also increase its value when you use the funds for home improvement. But this strategy can also work to pay off higher-interest debt, such as credit card debt, or other large life expenses.
After looking around to find the best price and terms for you, remember that you are borrowing money for your home and that if you are unable to repay it, you are putting it at risk.
