Summary
- Whether a home equity loan is a good idea or not depends on your specific financial circumstances. Homeowners that plan to put the money to good use have a stronger justification for turning their home equity into cash.
- Commom examples of good use of funds include investing back into your home via home improvements or upgrades, paying down expensive debt like credit cards or personal loans, or investing the funds in stable, higher rates of return.
- Common examples of bad use of funds include using your home as a piggybank (like travel, poor spending habits, etc), making poor investment decisions, or sitting on the cash (non-use of funds).
- Comparison to HELOC: Unlike the revolving credit of a HELOC with variable rates, a home equity loan provides a fixed sum with typically stable rates. Consider a HELOC over a home equity loan if you don’t have immediate use for all the funds or you expect interest rates to drop significantly in the near term.
As a homeowner, getting a home equity loan can help you improve your financial outlook if you put the funds to good use. Lenders rarely issue restrictions on how you can use these funds, so you can typically use them just as you would any other funds you have in your bank account. For instance, you can use the funds for debt consolidation to eliminate loans that have higher interest rates, pay for home improvements, or cover unexpected expenses.
However, getting a home equity loan does carry certain risks. For instance, you could lose your home in the event you’re unable to make timely payments. Also, since many home equity loans carry closing costs, you could end up paying more in fees if you’re not careful with how you use the money.
If you’re considering a home equity loan, continue reading for more details on the pros and cons. We’ll help you decide if it’s the right choice and how to go about getting a home equity loan if you decide that the benefits outweigh the risks. You can also utilize our service here at House Numbers to determine how you can access your home’s equity. It’s free and won’t affect your credit score!
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House Numbers helps you access your home equity to pay off debt, fund home improvement, or general expenses.
What is a home equity loan and what can funds be used for?
Unlike personal loans, a home equity loan works as a second mortgage that uses your home as collateral. This type of loan gives you a lump sum of funds based on how much equity you have in the home. For example, a home worth $500,000 with $300,000 as the mortgage balance would leave you with $200,000 in equity. A lender’s underwriting guidelines will then dictate how much of that equity you can access with a loan.
If approved for a home equity loan, funds can be deposited into a bank account of your choice. Once this is done, you can then use the funds as you would any other money. As a result, funds from a home equity loan can be used for virtually any purpose, although we recommend only doing so if it delivers some form of financial benefit. Common uses of home equity loans include:
- Conducting home improvements
- Paying off and consolidating other consumer debt
- Paying for college tuition or other educational expenses
- Paying for car repairs
Pros of home equity loan
Comparing a personal loan vs a home equity loan to pay off debt, a home equity loan can provide the following notable advantages:
Low-interest rate
Loans backed by the collateral of your home historically have the lowest interest rate. This lower interest rate charged by a lender is a reflection of the level of risk involved — nobody wants to lose their home so the borrower (homeowner) will work hard to make all their mortgage payments (whereas credit cards and personal loans have higher rates since your home is not at risk). The lender can foreclose and take possession of the collateral (ie, your home) should the borrower fail to pay the loan on time. This can then allow the lender to recoup its financial losses, lowering its risk of lending money on a home equity loan.
Ability to borrow larger amounts of money
If you have enough equity in the property and can otherwise afford the payments, it’s possible to get a larger loan amount with a home equity loan compared to other financing options. This is largely because home equity loans use the property as collateral, giving the lender the ability to foreclose in the event of a default. Unsecured loans, on the other hand, are a much larger risk for lenders. Without any collateral for the loan, their ability to recoup losses is limited. As a result, it can be challenging to find larger loan amounts elsewhere.
Long repayment period
Home equity loans often allow for between 15 and 30 years to pay off the loan in full. By spreading your payments over a longer period of time, your minimum payments will also be more affordable. Be aware though, that doing so means your home equity loan interest charges will be greater over the life of the loan. If this doesn’t appeal to you, also consider our tips for how you can pay less interest on your mortgage.
Fixed or variable monthly payment options
Home equity loans often have a fixed interest rate. This means that your required monthly payment will not fluctuate for the life of the loan. Other types of loans, by comparison, may have variable interest rates that can fluctuate over time, which can make it difficult to manage your finances.
With that said, a Home Equity Line of Credit (HELOC) has a variable rate interest option. If you feel rates are dropping, consider getting a HELOC instead of a home equity loan.
Cons of home equity loan
While home equity loans carry many benefits, there are also some downsides to consider before you apply for financing:
You risk losing your home
Home equity loans use your property as collateral. In the event of a default, you agree to give the lender the right to foreclose on the home. Consider the likelihood of this happening, as well as whether you have asset reserves to make loan payments in case you lose your primary source of income. Foreclosure timelines vary depending on your location but can start as soon as 120 days of being delinquent.
You’ll need to pay closing costs
If you’re getting a home equity loan, you’ll incur closing costs and certain fees, typically between 1% and 3% of the loan amount. Lenders must conduct a due diligence review of your credit, finances, and your property. This process requires them to obtain information from third-party vendors, the cost of which is passed on to you.
Home equity loans can take longer to fund
Home equity loans typically take between 21 and 45 days to fund. If you need money more quickly, you may need to consider another type of personal loan. Funding speeds can also vary depending on the complexity of your credit, finances, and property characteristics.
Some lenders have strict underwriting requirements
Getting a home equity loan can be difficult because some lenders have strict approval guidelines. This can often involve requesting lots of paperwork & loan documents from you to document various aspects of your credit and income to ensure you can afford the monthly home equity loan payments. As a result, those with unique or non-traditional circumstances may find it difficult to qualify for a home equity loan.
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How to get a home equity loan
To get a home equity loan, you’ll need to know where to apply and then meet a lender’s eligibility criteria. We’ll go through each of these in greater detail below.
Where to get one
Home equity loans are offered by many different banks, credit unions, online lenders, and loan brokers. Each has its unique set of pros and cons concerning things like rates, terms, flexibility of qualification requirements, and more.
Below is a chart where we compare each of these types of lenders in different categories. Keep in mind, however, that individual lenders can vary from what is shown below.
| Banks | Credit Unions | Online Lenders | Loan Brokers | |
|---|---|---|---|---|
| Geographic availability | Typically nationwide | May be limited | Typically nationwide | Typically nationwide |
| Rates and fees | Can be high | Average | Low | Can be high |
| Flexibility of underwriting guidelines | Low | High | Average | Low |
| Funding speed | 21 to 45 days | 10 to 30 days | 10 to 20 days | 10 to 20 days |
| Customer service | Average | Excellent | Average | Excellent |
Home equity loan requirements
To get approved for a home equity loan, you’ll need to meet a lender’s eligibility criteria. This commonly includes various aspects of your credit, income, and property, all of which can impact the interest rate you qualify for:
Credit
In addition to reviewing your credit score for a home equity loan, a lender will look at the details of your credit history to determine if there are any disqualifying factors. Guidelines vary from lender to lender but can include things like the number and type of delinquencies, the amount of your debt payments in relation to your income, the types of accounts you have experience with, recent credit applications, and more.
Income
To determine whether you can repay the loan, your income will be measured against your total monthly debt payments. Lenders will use this to calculate your debt-to-income ratio (DTI), which is one of several factors that determine how much of a mortgage you qualify for. Lenders commonly require it to be less than 50% to issue a loan approval. Lenders will also typically look at your prior two-year history to determine the stability of your employment.
Property
The value and condition of your home will be evaluated to determine whether it meets a lender’s guidelines. An appraisal inspection will typically be completed, designed to reveal potential health or safety hazards with the home. It will also provide an estimated value of the property to determine if you have enough home equity in your home to support the loan amount you’re requesting.
What the application process looks like
When you find a lender and submit an application, how long it takes to get a home loan varies, with an average of 30 days or more to get approved and funded. Much of this time is used by the lender in conducting a review of your entire loan application, ensuring it meets its underwriting guidelines.
Although the exact steps will vary among lenders, below are typical stages you’ll go through as part of the home equity loan application process:
- Application: The first part of the loan process requires you to submit a loan application. This gives the lender basic information about your credit, income, and type of loan you’re seeking.
- Submission of documents: Once your initial application has been reviewed, your lender will request items from you to confirm your eligibility for the loan. This can include things like tax returns, pay stubs, bank statements, loan statements, and more.
- Third-party services are ordered by the lender: As part of its mortgage underwriting review, lenders will order an appraisal inspection and title report for your home. These items serve to confirm the value, condition, and ownership status of the property. Depending on the details of your loan, other required third-party services can include home inspections, septic tank certifications, and more.
- Lender decision: Once it receives all required documentation, the lender will issue a decision on your loan. In some cases, it may require clarification on items either you or a third-party vendor has provided. At this stage, you’ll be given the rate and terms you’re eligible for.
- Loan doc signing: If you accept the loan terms, your next step will be to sign the final loan documents. This usually requires a notary public to visit your home to verify your identity.
- Funding: Once the final loan documents have been signed, they will be returned to the lender for one last review. If all documents have been properly executed, the lender will disburse funds to your bank account.
Home equity loans vs. home equity lines of credit (HELOC)
A home equity line of credit is a variation of a home equity loan. One of the biggest differences, however, is that a home equity line of credit is a revolving credit line that allows you to continue to draw funds up to the specified credit limit. As you pay down your balance, you can continue to draw additional funds. Rates also tend to be variable, so your payments can fluctuate over time.
By comparison, a home equity loan gives you a single lump sum of funds. If you were to need additional financing, you would need to submit another loan application. These also typically have fixed interest rates, so your monthly payments would stay the same for the duration of the loan.
Should I get a home equity loan?
Before you get a home equity loan, consider the benefits and downsides. Compared to other types of personal loans, home equity loans can offer more competitive interest rates which can help with paying off more expensive debt, covering unexpected expenses, or paying for home improvements. Doing so, however, means that you could risk losing your home if you’re no longer able to make the monthly payments on time. As with any loan, make sure you can afford the payments and consider your cash reserves or other options if you were to lose your primary source of income.
