How do you calculate home equity?
Home equity is simply the difference between your home’s market value and your outstanding mortgage balance. As an example, if you have a $300,000 home and owe $200,000 on your primary mortgage, you have $100,000 in equity.
What’s the difference between a home equity loan and a home equity line of credit?
As mentioned above, a home equity loan is paid out in a lump sum and repaid in fixed monthly installments over a set term. On the other hand, a home equity line of credit (HELOC), works much like a credit card. You can use the credit line up to the established limit, but you pay only for what you use — plus interest. HELOCs have a set draw period, during which you can use the credit line. When the draw period ends, the HELOC goes into repayment and you can’t tap any more equity from the credit line.
How do you apply for a home equity loan?
You must meet several home equity loan requirements to apply and qualify for a loan, such as:
- Having at least 15% equity. Your loan-to-value ratio should be 85% or lower, which means you have 15% equity or more in your home. In some cases, you may qualify for a home equity loan with a high LTV ratio.
- Having a minimum 620 credit score. Some lenders may have higher minimum credit scores, but you’ll need a score of 740 or higher to get the best interest rates.
- Having a maximum 43% debt-to-income ratio. The percentage of your gross monthly income used to repay debt — your DTI ratio — should not exceed 43%. Still, some lenders may accept a ratio as high as 50%.
It’s important to note that lenders typically limit the amount you can borrow to 85% of your home’s value, according to the Federal Trade Commission, so you likely won’t be able to tap the full amount. It’s also a good idea to leave some equity in your home in case you need to sell it suddenly due to a job change or personal financial emergency.
Are there any home equity loan tax benefits?
You may qualify for a tax deduction on your home equity loan, depending on how the money is used. If you took out the loan to buy, build or substantially improve your home, then you can likely deduct the interest paid on your monthly home equity loan payments under the mortgage interest deduction. However, the interest won’t be tax-deductible for other purposes, such as debt consolidation or buying a second home.
How much does a home equity loan cost?
Just as with your first mortgage, there are closing costs to pay on a home equity loan, which can range from 2% to 5% of your loan amount.
Costs typically include but may not be limited to:
- Loan origination fees
- Home appraisal fees
- Credit report fees
- Title search fees
- Lawyer fees