A home equity loan allows you to tap into some of your home's equity for cash, which you receive in the form of a lump-sum payment that you pay back at a fixed interest rate over an agreed period of time. This is typically between five and 20 years, though some lenders offer terms as long as 30 years.
A home equity loan could be a good idea if you use the funds to make home improvements or consolidate debt with a lower interest rate. However, a home equity loan is a bad idea if it will overburden your finances or only serves to shift debt around.
Deciding To Take Equity Out Of Your Home
Whether you choose a home equity line of credit (HELOC), a home equity loan, or a sale-leaseback agreement, you can unlock your home's equity while avoiding refinancing. This also applies to investment properties, too.
How you receive your funds. Cash-out refinance gives you a lump sum when you close your refinance loan. The loan proceeds are first used to pay off your existing mortgage(s), including closing costs and any prepaid items (for example real estate taxes or homeowners insurance); any remaining funds are paid to you.
By cashing out the equity you have built up: You can borrow up to 80% of the value of your property, minus what you still owe on it, if you can provide a stated purpose (no evidence required). You can release up to 90% of the property value, minus what you owe on it, with evidence of the use of the funds.
You get the money in a lump sum, and then you make regular monthly payments for a set period of time until you've paid it back. The loan is secured by your home, so the lender has a legal claim on the property in case you don't pay off the loan as agreed. Home equity loans usually have fixed interest rates.
A cash-out refinance lets you negotiate new mortgage terms, and at the same time, borrow funds for one-time expenses. A home equity loan allows you to borrow against the equity in your home and pay it back with a steady repayment schedule.
Many loan types require that you leave some equity in the home. To qualify for a cash-out refinance, Federal Housing Administration (FHA) and conventional loans require that you leave 20% equity in your home. VA loans are an exception, as they allow you to get a cash-out loan for 100% of the value of the home.
HELOCs are generally the cheapest type of loan because you pay interest only on what you actually borrow. There are also no closing costs. You just have to be sure that you can repay the entire balance by the time that the repayment period expires.
Like a mortgage, a HELOC is secured by the equity in your home. Unlike a mortgage, a HELOC offers flexibility because you can access your line of credit and pay back what you use just like a credit card. You can use a HELOC for just about anything, including paying off all or part of your remaining mortgage balance.
How much can you borrow with a home equity loan? A home equity loan generally allows you to borrow around 80% to 85% of your home's value, minus what you owe on your mortgage.
The best ways to get equity out of your home are through home equity loans, home equity lines of credit (HELOCs) and cash-out refinancing. Accessing your home equity can be a lower-cost way to borrow money for things like school tuition, paying off debts or home renovations.
A cash-out refinancing pays off your old mortgage in exchange for a new mortgage, ideally at a lower interest rate. A home equity loan gives you cash in exchange for the equity you've built up in your property, as a separate loan with separate payment dates.
Home Equity Loan Disadvantages
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Consider, too, that when you liquidate equity, you dilute your homeownership stake. That makes your property a less valuable asset and decreases your overall net worth. Tapping into equity increases your overall debt and what you will owe your lender — both in principal and interest — over time.
Don't: Use it to Pay for Vacations, Basic Expenses, or Luxury Items. You have worked hard to create the equity you have in your home. Avoid using it on anything that doesn't help improve your financial position in the long run.
Equity is your home's market value minus your mortgage balance. Although it's sometimes called a second mortgage, a home equity loan doesn't affect your mortgage. Your mortgage interest rate, term and payments stay the same—you'll just have another monthly payment.
To qualify for a HELOC, you must have equity in your home and maintain a low debt-to-income (DTI) ratio. You will also need a good credit score and proof of income. The amount you can borrow with a HELOC depends on the value of your home and the amount of equity you have built up.
You can take equity out of your home immediately or only a few months after closing, depending on the lender. However, you'll incur closing costs. So, it might be better to wait a while since you'll need to pay some money upfront to pull equity out of your home.
A lower credit score doesn't necessarily mean a lender will deny you a home equity loan. Many home equity lenders allow for FICO scores as low as 620, considered “fair,” as long as you meet other requirements around debt, equity and income.
A home equity loan is a loan that allows you to borrow against your home's value. In simpler terms, it's a second mortgage. When you take out a home equity loan, you're withdrawing equity value from the home. Typically, lenders allow you to borrow 80% of the home's value, less what you owe on the mortgage.
Just as you did with your original mortgage, you'll need to meet qualifying criteria to be eligible for a cash-out refinance. These requirements include: Credit score: Generally at least 620. Debt-to-income (DTI) ratio: 43 percent or lower.
Conventional refinance: For conventional refinances (including cash-out refinances), you'll usually need at least 20 percent equity in your home (or an LTV ratio of no more than 80 percent).
Refinancing might be the best choice if your primary goal is to lower your monthly payment or pay off your mortgage faster. If you want cash for improvements, education expenses or to purchase something you've been dreaming of, then consider a home equity installment loan.
It can be accessed in the form of a home equity loan, home equity line of credit or cash-out refinance. Tapping these funds can give you access to cash, often at lower rates than personal loans or credit cards.