Applying for a Home Equity Loan or HELOC in 2022
Applying for a Home Equity Loan or HELOC in 2022

If you’ve owned a home for a while now, you know it’s more than just a piece of the American dream. It can also be the most valuable asset you own – an asset you can tap into when you need to borrow money, either through a home equity loan or a home equity line of credit (HELOC). Here’s what you need to know to apply.

Key points to remember

  • Home equity loans and home equity lines of credit are based on the difference between the current value of your home and the amount you still owe on your mortgage.
  • Home equity loans tend to have lower interest rates than other borrowing options because they are secured by your home and considered less risky to lenders.
  • A home equity line of credit works like a credit card, in that you have a fixed credit limit that you can borrow from when you need it and then pay it back over time.

Home Equity Loans vs. HELOCs

When it comes to borrowing money, a home equity loan and HELOC are secured by the most important collateral you can offer – your home. As long as you have the equity in your home, which is the difference between the amount you currently owe on your mortgage and the current market value of your home, you can qualify for a loan on equity or a HELOC for a portion of that equity. Here’s how the two differ:

What is a home equity loan?

Home equity loans work like other types of loans. When approved by a lender, the borrower receives the entire loan in one lump sum. The borrower can spend the money as they see fit, such as debt consolidation, emergency bill payment, or a home improvement project. The borrower must then repay the loan through a series of scheduled payments. The term of a home equity loan can range from 5 to 30 years.

Home equity loans have a fixed interest rate. This rate will generally be lower than what the borrower might get on other types of loans, because using the house as collateral makes the loan a safer bet for the lender.

Home equity loans are also commonly referred to as second mortgages or home equity installment loans.

What is a home equity line of credit (HELOC)?

While home equity loans work like traditional loans, a home equity line of credit works the same way as a secured credit card, except that instead of cash in the bank serving as collateral, the the borrower does.

Once approved, the borrower can withdraw money through a revolving line of credit. So the owner can borrow a portion of their current credit limit, spend the funds, repay those funds with interest, and then withdraw more money later. This allows the owner to access cash when they need it rather than all at once. This could be useful, for example, if you plan to remodel your kitchen this year and add a patio in a year or two.

Unlike a home equity loan, but similar to most credit cards, HELOCs have a variable interest rate. The rate will fluctuate over time depending on market forces, the borrower’s credit rating and the amount they are borrowing at any given time. This results in a minimum payment that can increase or decrease between scheduled payments, making HELOCs less predictable to the borrower than home equity loans.

Requirements to apply for a home equity loan or HELOC

If you know exactly how much you need to borrow and know that you can repay that amount over several years, then a home equity loan is probably the right choice for you. However, if you’re not sure how much you’ll actually need to borrow or how long you’ll need to keep withdrawing money, you should consider a HELOC instead.

Once you’ve made that decision and want to move forward, there are some things you’ll need to have in line before a lender will approve you. Generally, both options have similar requirements, although each lender is different and may require something that their competitors do not. Laws may also differ from state to state. Here are some of the requirements you are likely to encounter:

  • You will need sufficient capital. First, of course, you will need to have equity to borrow. Keep in mind that lenders will not allow you to borrow the full amount of your capital, but will generally limit you to no more than 85% of it. So, if you have accumulated $50,000 of equity, you may be able to borrow up to $42,500 if you meet all other conditions. Also note that home equity loans and lines of credit usually have closing costs of several thousand dollars, so you’ll walk away with less than the amount you borrowed.
  • You will need a good credit rating. Potential lenders will also expect you to have a a strong credit score, which they use as an indicator of how risky you are lending. Although lenders differ, most will want to see a credit score in the mid-600s or above before they even consider your application. Obviously, the higher your credit score, the better. (The highest possible credit score is 850, but anything over 670 is considered good.) The lender will also check your credit report for additional information regarding your creditworthiness, including the types of credit you have. have, how much you owe, how long these accounts have been open and if you have any late payments on your file.
  • You can’t have too many other debts. The lender will also consider your debt-to-income ratio (DTI), which measures how much of your monthly income has already been allocated to other unpaid debts. You will likely need to provide proof of income in the form of pay stubs, W-2 forms, or other relevant documents. In most cases, lenders will want to see a DTI no higher than 36%, although some may be as high as 43%. All of your monthly borrowing expenses, including your existing mortgage payment, any student loan debt, credit card bills, and other debt, are added together and then divided by your monthly income to arrive at this number.

The essential

If you have equity in your home, a home equity loan or HELOC can be an easy way to leverage some of that equity for other purposes. What will work best for you basically comes down to whether you need to borrow a fixed amount now or whether you prefer a more flexible line of credit that you can draw on as needed.

Keep in mind, of course, that a home equity loan or HELOC will put you further into debt, which could be a problem if you suffer a serious financial setback due to job loss, large medical bills or other unforeseen events. And because these loans are secured by your home, you could potentially lose it if you’re unable to meet the payments.

How much equity do I need to get a home equity loan?

Most lenders will want you to have at least 15-20% of the equity in your home before and after the home equity loan. So, for example, if your home is currently worth $300,000 and you still owe $270,000 on your mortgage, your equity is $30,000, or 10%. In this case, you probably wouldn’t qualify for a home equity loan or HELOC. If, however, you only owed $200,000 on your mortgage, you would have $100,000, or 33%, in equity, and you would most likely qualify.

How do I determine the equity in my home?

To determine the equity in your home, you will need two numbers.

The first is the amount you still owe on your mortgage. This number may appear on your monthly mortgage statement or on the mortgage amortization schedule provided by your lender. Or, you can just call your lender and ask.

The second number is the current value of your home. You can get a rough estimate by asking a local real estate agent or checking how much homes comparable to yours have sold for recently. For a more accurate estimate, you can hire a professional real estate appraiser.

What are the alternatives to a home equity loan or line of credit?

If you are unable to obtain a home equity loan or HELOC, you may qualify for a personal loan from a bank or other lender. These loans tend to have higher interest rates than a home equity loan or HELOC, but with an unsecured personal loan, you won’t be putting your home at risk.

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