How to Get a Home Equity Loan
One of the top benefits of homeownership is the ability to build equity. Your monthly payments help turn your humble abode into a nest egg — something that’s simply not possible with rent payments.
This equity can later be used to help achieve your financial goals, from remodeling your home to consolidating your high-interest-rate debt.
But you can’t just pull from your available equity on demand. You’ll need to go through an application and qualification process to prove you’re a creditworthy borrower. Keep reading for guidance on how to get a home equity loan.
What is a home equity loan?
A home equity loan is a financial product that allows you to borrow against the difference between your home’s market value and your outstanding mortgage balance — known as equity. For example, if your home is worth $250,000 and you owe $150,000 on your home loan, then you have $100,000 in equity. You may also hear home equity loans referred to as a “second mortgage.”
Similar to a first mortgage, a home equity loan is an installment loan secured by your home. You’ll receive the money in a lump sum and have a fixed interest rate and monthly payment. If you fail to repay the loan, you can lose your home to foreclosure.
Another way homeowners can tap into their equity is through a HELOC, or home equity line of credit. A HELOC is a revolving credit line, similar to a credit card, with a variable interest rate. You only pay for what you use, plus interest.
How to qualify for a home equity loan
If you’re thinking of getting a home equity loan, you’ll first need to make sure you’ve built up equity in your home. You calculate your equity amount by taking your remaining mortgage balance and dividing it by your home’s market value. That’s your equity.
Once you’ve determined how much equity you have, keep in mind that lenders won’t allow you to borrow the full amount. Your combined loan-to-value ratio — your remaining mortgage balance, plus your hypothetical home equity loan amount, divided by your home’s value — typically can’t exceed 85% or 90%. So if you have a home worth $250,000, and a mortgage of $150,000 — you typically can borrow about $62,500.
As part of your application, lenders will review your income by requiring you to submit pay stubs, tax returns and/or W-2s. They will also pull all three of your credit reports and scores and review your existing debt load to determine your debt-to-income ratio.
Aim for at least a 700 credit score, though it may be possible to qualify with a 660 score. You should also try to keep your debt-to-income ratio below 43%, though you may still be able to obtain a loan with a ratio as high as 50%, in some cases.
Applying for a home equity loan
To get the best deal, be sure you shop around with multiple home equity lenders — mortgage companies, banks, credit unions, etc. There are costs involved with borrowing a home equity loan, including a potential appraisal fee if your home requires an updated value assessment. You may also incur a fee if you pay off the loan earlier than expected.
The best way to ensure you cut down on borrowing costs and fees is to compare the Loan Estimates you’ll receive from each lender after you apply for a home equity loan and negotiate where possible.
If you’re approved to borrow against your equity and you sign on the dotted line, federal law allows you to cancel the home equity loan — with notice in writing — within three business days without any penalties. Your lender isn’t allowed to disperse the funds to you during the three-day waiting period, according to the Federal Trade Commission.
What if you’re underwater?
As previously mentioned, a main component of qualifying for a home equity loan is verifying that your outstanding loan balance is lower than your home’s current market value. If the reverse is true for you — in other words, you have negative equity — you wouldn’t be eligible for a home equity loan or even a HELOC.
Having negative equity, or being “underwater” on your home, means you owe more on your home than what it’s worth. Nearly 9% of mortgaged properties have loans that are at least 25% higher than their estimated market value, according to a report from real estate analytics firm ATTOM Data Solutions.
One method to start building positive equity is to aggressively pay down your mortgage. Consider one or more of these eight ways to pay off your mortgage faster.
Another option is to recast your mortgage. In a mortgage recasting, you pay a lump sum of money toward your outstanding loan balance. Your lender then reamortizes your loan based on your new principal balance — your loan term and interest rate won’t change, however.