Home equity loans, a type of second mortgage, have increased in popularity within the last few years. In 2018, TransUnion projected that 1.6 million home equity lines-of-credit would be originated — doubling the number previously seen in 2013.
What is a home equity loan?
Home equity is the amount of money on your house that you’ve paid off. One of the most attractive aspects of home equity is that it often increases by you simply paying your mortgage every month. Home equity loans allow you to borrow against your home’s value, less any outstanding mortgage or loan balances.
How do home equity loans work?
Home equity loans can provide you with access to large amounts of money, and they can be a little less arduous to qualify for than other types of loans as you’re putting up your home as collateral. This, of course, comes with inherent risks. If you fail to make repayments, your lender can foreclose on your home.
What’s the difference between home equity loans and lines of credit?
Home equity loans give you a lump sum of cash upfront, which you can then repay monthly with fixed installments. Each of your monthly payments is applied to your loan balance as well as some of your interest costs.
With a home equity line of credit (HELOC), you don’t receive a lump sum but rather a maximum amount available for you to borrow, which you can access whenever you like. This option essentially acts similar to a credit card, allowing you to borrow multiple times. HELOCs are more flexible because you have more jurisdiction over your loan balance, and you only pay interest on the amount you actually use.
Keep in mind that with HELOCs, if your home astronomically drops in value or if your financial situation changes and your lender believes you’ll have trouble making payments, they can freeze or cancel your line of credit. So while HELOCs are more flexible, they do come with their own unique risks.
What do you need to qualify for a home equity loan?
In order to qualify for a home equity loan, you’ll need to meet a few basic minimum requirements:
- Credit score. You’ll need a credit score of 620 or higher.
- Loan-to-value ratio. You’ll need a LTV of 80%, or 20% equity in your home.
- Debt-to-income ratio. You’ll need a debt-to-income ratio of 43% or lower.
- Documented ability to repay your loan.
For your first mortgage, you likely did a lot of research on lenders and compared interest rates and APRs. Applying for a home equity loan is no different. You’ll want to compare rates and fees, and be sure to read the fine print. As always, don’t take out more than you can afford to pay back.