Updated August 28th, 2019
Property owners seek out external financing for many different reasons, but it’s safe to assume that most homeowners share two common prerequisites when taking out a loan: get the money fast and at an affordable rate. Home equity financing meets both of these prerequisites, making it an increasingly popular option for homeowners in need of a fast, low-rate loan.
Whether you’re facing urgent debt repayments, pre-sale home improvement costs, or a discounted fast-sale on a second property, situations often arise that require you to have cash fast.
If you’re approved for a home equity loan, you can have a lump sum of cash in your bank account in as little as two weeks — all without racking up any high-interest credit card or personal loan debt.
If you want to know whether you’re eligible for a home equity loan or if you’re planning on using home equity financing to purchase a second property, we recommend that you reach out and discuss your options with a top agent in your local area.
In the meantime, we’ve compiled a comprehensive guide to home equity financing — read on to learn more about what a home equity loan is, how long it takes to get one, the pros and cons of equity loans, and much more!
What is a home equity loan?
A home equity loan, also known as a second mortgage, is a type of loan that uses the equity in your primary residence as collateral. Lenders generally allow you to borrow against 80% to 85% of your home equity. Check out the following example to get an idea of how this works in real life:
Imagine that you owe $150,000 on your mortgage and your property has an appraised value of $250,000. In this case, you’d have $100,000 in equity, allowing you to take out between $80,000 and $85,000 through a home equity loan.
You can access home equity financing through two main loan options: a lump sum payment (home equity loan) or a home equity line of credit (HELOC). We’re going to look at each of these loan products more carefully in the next section of this article.
When you apply for a home equity loan, you’re effectively borrowing against your personal ownership stake in your primary residence. If you’re unprepared for a sudden change in your financial situation, using your home as collateral can have serious consequences! To compensate homeowners for such favorable collateral conditions, lenders typically pack home equity loans with a range of attractive options, including fixed interest rates and flexible loan repayment plans.
How to Apply for a Home Equity Loan
While it’s always best to consult directly with a real estate professional, we’ve listed the three basic steps you need to remember when applying for a home equity loan.
1. Determine your home equity
In order to calculate how much equity you hold in your home, you’ll need to conduct either a limited scope or full property appraisal.
2. Check the qualification requirements
Because home equity loans are secured by real estate ownership stakes, borrowers usually find the loan qualification requirements to be relatively manageable. We’ve listed four of the most important qualification requirements below:
- You need to hold between 15% to 20% of the equity in your home.
- You need to show evidence of both an income record and proof of steady employment.
- You need to have a debt-to-income (DTI) ratio of less than 50% (a DTI ratio of less than 43% is more preferable).
- You need to have a FICO Score of at least 620.
3. Choose a home equity lender
Home equity loans are offered by most major banks and mortgage companies. Don’t be afraid to shop around to ensure you’re getting the best possible deal on loan conditions and interest rates. Once you’ve chosen a lender, all you need to do is get in touch and submit the appropriate application documents.
How Long Does It Take to Get a Home Equity Loan?
The time it takes for a home equity loan to be approved is dependent on a number of different factors, including the strength of your initial application, the number of loans your lender is in the midst of processing, and your responsiveness to requests for additional documentation.
The standard response you’ll receive from lenders is that loan underwriting and approval takes between 2 and 6 weeks. However, if you have a high-band credit score, there’s a good chance you’ll receive approval even earlier. If you change your mind after being approved for a home equity loan, you’ll typically have a three day grace period to cancel the loan.
Home Equity Loan vs Home Equity Line of Credit
Home equity loan: A home equity loan essentially functions as a second mortgage. Upon receiving a lump sum of cash, you make monthly payments, at a fixed interest rate, for the life of the loan. Closing costs for home equity loans usually range from 2% to 5% of the loan value. For a $150,000 loan, this amounts to between $3,000 and $7,000 in settlement costs and fees.
Home equity line of credit: When you take out a HELOC, instead of receiving a one-time lump sum payment, you’ll be able to access a revolving line of credit. Similar to a credit card, a HELOC can be used repeatedly throughout the life of the loan, as long as you’re paying off the interest balance on time.
Borrower beware! HELOCs are typically offered at an adjustable interest rate. However, unlike standard adjustable rate mortgages, HELOCs don’t have a cap on variable rate adjustment. This can leave you dangerously vulnerable if there is prolonged upward pressure on the prime lending rate.
On the bright side, borrowers who take out HELOCs tend to pay less in closing costs and fees. For a $150,000 HELOC, settlement costs rarely exceed $1000. Moreover, lenders frequently cover some, or even all, of HELOC closing costs.
Pros and Cons of Home Equity Loans
To better understand the utility and rising popularity of home equity financing, we’ve broken down the respective pros and cons of home equity loans:
Advantages of Home Equity Loans
- Homeowners can use a home equity loan to pay emergency bills, high-interest debt, or otherwise out-of-reach expenses.
- Home equity loan settlement costs and underwriting fees are usually covered by your lender.
- As interest rates for home equity loans are generally lower than the interest rates on student loans, home equity financing is often a more affordable way of paying for college or postgraduate school.
- If you use a home equity loan or HELOC to “buy, build, or substantially improve your home,” the IRS allows you to classify the interest on the loan as a tax-deductible expense.
Drawbacks of Home Equity Loans
- If you can’t keep up repayments on a home equity loan, your lender has the right to seize and sell your home.
- If you take out a home equity loan with a low credit score, you’ll waste a significant amount of money on high-interest loan repayments.
- Taking out a home equity loan normally increases the time it takes for you to completely pay off your mortgage.
- In the event of a housing market crash, lenders reserve the right to cancel unused home equity loans or HELOCs.
Next Steps: Get Help from an Expert
If you’re planning on taking out a home equity loan to buy a rental property or second home, it’s probably time to get help from a professional real estate agent. An experienced agent will not only guide you through the ins and outs of applying for a home equity loan — they’ll also refer you to reliable local lenders and advise you on alternative financing options.
To connect with a top-rated agent in your local area, get in touch with Clever. When you buy through a Clever Partner Agent, you’ll benefit from full-service agent support, fast-tracked home showings, and, if you’re an eligible buyer, a $1,000 Home Buyer Rebate to put towards closing costs.
Top FAQs About Home Equity Loans
Are equity loans a good idea?
The answer to this question depends on your personal financial requirements and maturity. If you’re aware of the long-term obligations of home equity financing and intend to use the money for the right reasons, equity loans can be a great idea. However, if you plan on using a home equity loan to pay for lavish or unnecessary expenses, tapping into your hard-earned home equity is probably not a good idea.
What credit score do you need to get a home equity loan?
When assessing home equity loan applications, loan underwriters typically pay close attention to your credit score and your DTI ratio. If you have a credit score of at least 620 and a low-risk DTI ratio, there’s a good chance you’ll be approved for a home equity loan.
Remember, if you take out a home equity loan with a low-band credit score, you’ll likely end up paying significantly more interest on the loan. If you want to see for yourself how much of a difference a poor credit history can have on your loan interest rate, check out this FICO/Rate chart for home equity loans underwritten on 620-639 FICO scores compared to 740-850 FICO scores.
How do you pay back a home equity loan?
In most cases, home equity loans are paid back monthly, at a fixed interest rate, over a multi-year repayment term. Home equity loans are usually offered on 5, 10, or 15 year repayment terms.
If you’ve taken out a HELOC, repayment of the loan takes place over two phases: the draw period and the repayment period. During the draw period, usually between 5 and 10 years, the borrower is only required to make interest payments on the loan. When the draw period ends, HELOC loans convert to a conventional repayment term, usually between 10 and 20 years, and the borrower will need to make monthly payments on both the interest and principal.
Can home equity loans be used for anything?
Yes, for the most part, you can put your home equity loan towards whatever you want. However, and we can’t stress this enough, you should not be taking out a home equity loan in order to purchase luxury items or pay for day-to-day expenses.
If you’re not sure whether you should take out a home equity loan, ask yourself if your intended use of the loan fits into one of the following categories of spending:
- Emergency expenses.
- High-interest debt consolidation.
- Value-adding home improvements.
- Sensible investment purchases.
Is it better to refinance or get a home equity loan?
Unlike a home equity loan, which is a secondary loan on top of your mortgage, a cash-out refinance functions as a brand new mortgage. If you’re approved for a cash-out refinance, you’ll receive a lump sum cash payment and your mortgage will be refinanced at a new interest rate and under new repayment conditions.
In most cases, the interest rate on a cash-out refinance will be lower than the interest on a home equity loan. This means that refinancing is usually a better choice if you’re looking to reduce your mortgage interest rate. However, if your mortgage interest rate is already in the 3% to 5% range, a home equity loan will typically be a more affordable cash-out option.