Most of us know there are many advantages associated with being a homeowner including utilizing the equity in your home in the form of a home equity loan.
Of course, being a homeowner doesn’t automatically qualify you for a home equity loan. You must have a certain percentage of equity, the income and credit to support the loan.
This article will walk you through what a home equity loan is, discuss pros and cons, and outline what you may need to qualify for a home equity loan in 2019.
What Is A Home Equity Loan?
A home equity loan is a loan you take out against the equity in your home. You use the value of your home to get a lump sum payment from a lender. Many people use home equity loans to make home improvements, pay for large expenses or even college tuition.
You can determine the equity of your home by taking the value of your home and subtracting the mortgage balance.
Home Value: $100,000
Mortgage Balance: $50,000
To determine your home’s value, you can use online property value tools, or check with your county or city real estate assessment office, but the most accurate method is to get an official appraisal (which typically costs around $300-$400).
In the example above, the homeowner could potentially take out a loan for $50,000. Sounds simple, right? Well, there’s a bit more to it as you will read below, but this example provides a general idea of the concept. There are several other factors we will discuss below and some tips to help you decide if a home equity loan is right for you.
When Should I Consider A Home Equity Loan?
The thought of borrowing thousands of dollars at a low interest rate can be very appealing when you are looking to improve your home or pay for other expenses, but home equity loans aren’t the best option for everyone.
The pros of taking out a home equity loan are that you tend to qualify for lower interest rates compared to that of a credit card or even a personal loan with a bank or credit union. Lower interest rates lead to less money paid over the life of the loan.
It is also easier to meet home equity loan requirements and be approved, compared to other types of loans, because your home can be used as collateral in case you fail to make your payments.
The cons of taking out a home equity loan are that you are incurring additional debt. Just like an auto loan you will have a monthly payment to repay the loan. Also, there could be fees incurred as part of the home equity loan process, including closing costs which can amount to a few thousand dollars so make sure to ask about potential fees before applying.
Also, just like with any type of loan, if you fail to keep up with, or make, payments your credit can be negatively impacted or your lender may attempt to seize the asset.
So, now that you understand the basic pros and cons, it’s important to note home equity loans shouldn’t be used for insignificant purchases. Home equity loans often make sense for reasons including:
- Upgrading your home or making necessary home improvements
- Paying off medical bills
- Consolidating credit card debt
- College tuition and fees
- Purchasing a new vehicle – to determine whether this option is right for you, we’ve developed a calculator to compare the cost of using a home equity loan to finance your next vehicle purchase versus using traditional auto financing
Factors For Meeting Home Equity Loan Requirements
Having equity in your home does not mean you will instantly qualify for a home equity loan. You must meet certain qualifications, just as you did when you secured your mortgage or any other loan you’ve acquired.
The minimum credit score is generally 620. It is more challenging to qualify for a home equity loan with a credit score below 620. The closer your score gets to 700, the more likely you are to meet home equity loan requirements.
Loan Repayment Ability
As with any loan, you must demonstrate your ability to repay it. Your bank or credit union will verify your income and review your debt to income ratio.
It is recommended that your debt to income ratio, which is the amount of debt you have compared to your income, be less than 50%. Here is a calculator to determine yours.
Loan to Value Ratio
Your loan to value ratio, or LTV, can be a max of 80% or 20% equity in your home. Your LTV is calculated by taking your loan balance, adding it to the amount you want to borrow and dividing it by your home’s market value.
Here’s a loan to value ratio example:
Home value: $100,000
Mortgage balance: $50,000
Home equity loan desired: $20,000
You take the desired amount ($20,000) + the mortgage balance ($50,000) = $70,000
Then divide $70,000 by the value ($100,000) = a loan to value ratio of 70% which is within the requirements.
Meeting Home Equity Loan Requirements
While these are basic home equity loan requirements, all credit unions and lenders have their specific minimum qualifications, so you should shop around to find the best deal for you.
Deciding to take out a home equity loan is a big decision, and the funds you borrow can make a huge difference in your life whether you are making major home repairs or paying off significant high-interest debt.
If you are a considering a home equity loan and live, work, worship, volunteer or attend school in many of the counties around a Belco location, get in touch to see if a Belco Home Equity loan is right for you.