A home loan is a personal loan secured by the value of your home. It is often the easiest form of personal credit for individuals to obtain. Although requirements vary, most lenders will lend to borrowers who have more than 15% equity in their home and a credit score of 650 or higher. Consider working with a financial advisor if you’re looking to use your home equity to borrow.
What is a home equity loan?
A home equity loan is like a mortgage. The lender will give you a lump sum payment, which means you will receive the money all at once, the amount being based on the value of the underlying property. You then repay that loan on a set schedule and interest rate.
In most cases, a home equity loan has a fixed interest rate (meaning it doesn’t change once the loan is made) and payments are monthly. Interest rates tend to be lower than with other forms of personal loans because the loan is secured by your home.
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It also creates a risk. Just like with a mortgage, if you fail to repay a home equity loan, you can lose title to your home. This can happen in different ways. With minor loans (meaning a loan that represents a smaller portion of the overall home value), the lender can simply put a lien on the property. However, in severe cases, the lender can seize and sell the home, taking the balance owing.
Unlike some mortgage programs, there are no residency requirements with standard home equity loans. You can use any property as long as the lender feels the value of the property justifies the loan.
Requirements for getting a home equity loan
Each lender will have different requirements when it comes to issuing a home equity loan. However, many of these stipulations are remarkably similar to those of a mortgage itself. Here are some of the key terms that most lenders will focus on:
At least 15% – 20% equity in your home
Equity is the amount of your home that you own as opposed to the amount that you owe. For example, let’s say you bought your house for $400,000 and paid $75,000 on your mortgage after making a down payment of $25,000. You then have 25% equity in the property because you still owe the remaining $300,000 of the home’s value.
Most lenders require that you have at least 20% of the equity in your home before giving you a home equity loan. Many won’t lend beyond the 20% home equity mark, which means between your home loan and your mortgage combined, they don’t want you to owe more than 80% of the home’s value. Some will give a loan if you have at least 15% of the equity in your home, but it’s rare for legitimate lenders to give a loan to someone with less than that.
Never borrow more than your home is worth, even if the lender is willing to take out the loan.
A debt ratio below 36%
Your debt-to-equity ratio is the ratio of the amount of money you pay each month on existing debts to the amount of money you earn each month. For example, let’s say you earn $5,000 per month. You’re also paying $1,000 a month on credit cards, student loans, and car payments combined. Your debt to income ratio would be 20%.
Most lenders, under most circumstances, look for a debt to equity ratio of around 36% or less before extending a new line of credit. It’s not a hard and fast rule, but it’s quite common. Home equity loans are the same. Since this is a secured loan, lenders may be more lenient than usual on this requirement, but expect most to start at least at the standard 36% .
Fair or better credit score
Credit is very flexible here. Usually, a lump sum personal loan requires high credit and rigorous standards. Lenders aren’t exactly lining up to hand over a bag of unsecured money. However, since it is a secured loan, they are willing to accept much looser standards.
Each lender is uniquely different when it comes to credit on a home loan. However, as a general rule, expect your lender to seek a credit score of at least the mid-600s. Some may drop as low as 620 or 640 before raising a red flag. This is good news for potential borrowers with poor credit, but only somewhat. You could get the loan, but with a credit score below 700, you should also expect a very high interest rate.
Home Equity Loan vs. HELOC
There are two main types of loans you can take out with your home equity: a home equity loan and a home equity line of credit (HELOC). They are similar, but not identical.
A HELOC is, as its name suggests, a line of credit. It works just like a credit card. (In fact, a credit card is a line of credit.) You have a maximum amount that you can borrow at any time. You can borrow and make payments on this line of credit according to its terms, as long as you never owe more than the maximum allowed. This is a continuing form of loan.
A home equity loan is a one-time loan. You receive a lump sum upfront and then make payments over time. If you want more money, you have to apply for another loan. For this reason, it is common for home equity loans to be somewhat larger than HELOCs.
What to pay attention to
Home equity loans are one area borrowers should be wary of. This industry is one that often encourages predatory behavior. It’s common for lenders to be far less interested in getting a payment than in getting your home. This is not a general warning against home equity loans. Be careful before borrowing from an unknown lender and be especially careful before borrowing from a lender with soft terms. If someone has a “No Credit, No Problem” sign on the front door, you’d definitely be better off talking to your neighborhood bank.
And if you’re looking for a loan with poor credit, it can’t hurt to check your state’s usury laws. Many dishonest lenders try to charge borrowers high interest payments with the intention of pushing the borrower into default. This writer has represented clients on exactly this issue.
To learn more, the FTC has a fact sheet on how to spot good and bad lenders. Rogue home equity lenders are a problem for law enforcement in every state. Therefore, if you believe you have been the victim of a scam, do not hesitate to contact your local attorney general’s office or a lawyer.
Home equity loans are lump-sum loans you take out that are secured by the value of your home. You make payments at a fixed interest rate and schedule, similar to how you would with a mortgage, and they can be a great way to access high-value loans for individuals. However, make sure you meet the requirements for a home equity loan because if you do it too soon, you will likely be turned down.
Big loans are a powerful tool, which means we should use them with respect. Under the right circumstances, a large loan can help you secure another property, increase the value of an old one, access investments and even go to school. But what are the right circumstances? A financial advisor can help you figure this out. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
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