Key Takeaways
- Getting a home equity loan works much like a mortgage: shop lenders, apply with documents, complete an appraisal, then close and receive a lump sum.
- Approval and rates depend on your credit score, debt-to-income ratio, and how much equity you have, typically up to about 80% of your home’s value minus your mortgage balance.
- Home equity loans can offer lower, fixed rates than other debt, but since your home is collateral, it’s important to weigh the risks.
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A home equity loan can be an efficient way to turn built-up equity into cash without touching your current mortgage. The process closely mirrors getting a mortgage, from shopping rates and submitting documents to completing an appraisal and closing.
If you’re considering this option, this guide walks you through each step.
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What is a home equity loan?
A home equity loan is a type of lending product that allows homeowners to borrow against the equity they’ve built up in their homes.
This equity refers to the difference between the market value of the house and the remaining mortgage balance. Home equity loans are often used to finance large expenses such as home improvements, student loans, or to consolidate high-interest debt.
The interest rates associated with a home equity loan are typically lower than those associated with personal loans or credit cards. Because of this, they are a popular choice for people looking to fund large projects or make large purchases. However, because these loans use your home as collateral, failing to make loan payments may result in the loss of your home.
How does a home equity loan work?
Home equity loans work similarly to primary mortgages. After qualifying for the loan based on your credit score, income, and the amount of equity in your home, the lender provides a lump sum of money. You’re then obligated to repay this amount, along with interest, in fixed monthly payments over a predetermined period (the loan terms).
The amount you can usually borrow is a percentage of your home’s appraised value minus the amount you still owe on your mortgage. This total establishes a credit limit for your loan.
It’s important to note that as you make loan payments, you’re not just paying loan interest; you’re also paying down the principal loan amount. This structure differs from interest-only payment structures, where borrowers pay interest during the initial loan term and then pay off the principal in a lump sum.
While home equity loans can provide significant financial resources for things like home improvements or paying down high-interest debt, they also come with risks. The most notable is the risk of foreclosure if loan payments are not made. Therefore, it’s critical for homeowners to carefully consider their ability to make monthly payments before taking on a home equity loan.
Video: How to get a home equity loan
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How to get a home equity loan: Step-by-step process
Your home isn’t just a place to live; it’s also a potential source of financial flexibility. But understanding how to obtain a home equity loan can seem daunting at first. Don’t let that stop you! Here, we demystify the home equity loan process.
Ready to unlock the value in your home? Let’s show you how to apply for a home equity loan.
Step 1: Decide how much cash you need
The first of the key steps to get a home equity loan is deciding how much cash you need. Unlike a home equity line of credit (HELOC), which allows you to tap your equity as needed over time, a home equity loan requires you to borrow a specific loan amount upfront. Calculate how much money you need before applying for a loan, as the amount you borrow affects the total cost.
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“Borrowing more than you need may sound tempting, but that directly affects your interest rate and total payment,” says Dennis Shirshikov, a strategist at Awning.com and professor of economics and finance at City University of New York. “Putting an extra $10,000 in the bank may seem like a good idea. [But] you will end up paying much more than that in combined principal and interest over the life of the loan.”
Before you begin the process of getting a home equity loan, know exactly how much cash you need and how you’ll use it to avoid overpaying on interest and fees.
Step 2: Check your credit
Your credit score matters when applying for a home equity loan. You’ll generally get a lower interest rate and better terms if your score is 700 or above. The minimum score needed to qualify is usually 620.
To check your credit score for free, inquire with your bank or lender or log into your credit card account (many credit card issuers provide free credit scores). Just note that free scores may be higher than what a mortgage lender will see. For a more accurate number, you can purchase your credit score directly from Experian, TransUnion, Equifax, or FICO.
If your score is lower than desired, try to improve your credit before starting the home equity loan approval process.
You can improve your credit by paying your bills on time, not opening any new accounts or lines of credit, paying your amounts due in full versus the minimum balance, and correcting any inaccuracies you see on your three free credit reports. Keeping your credit usage below 30% of your total limit helps keep your score healthy.
Step 3: Compare interest rates and lenders
When you’re ready to apply for a home equity loan, the first step is to get quotes from multiple lenders and compare your offers. Rates and fees vary considerably from one lender to the next, so shopping for the best deal is important. Banks, mortgage companies, credit unions, and online lenders offer home equity loans.
“After you know how much equity you have, it’s time to start shopping for lenders. Compare rates and terms from several lenders before choosing one,” suggests Boyd Rudy, associate broker with Dwellings Michigan. “Be sure to compare not only interest rates but also closing costs and fees.”
Check your home equity loan rates. Start here
Step 4: Complete a home equity loan application
You’ve chosen your preferred lender. Now it’s time to move forward with the home equity loan steps and formally apply for the loan, which can be done online, over the phone, or in person if the lender has a brick-and-mortar office.
When it comes to filling out your application, the steps for a home equity loan are similar to any other mortgage. Lenders will ask for the same types of financial documentation. And if anything is unclear or the underwriter finds an issue, you might be asked for supporting documents or a letter of explanation.
“The application process will vary from lender to lender. But most will require you to fill out a form and provide financial documentation, such as tax returns, bank statements, and proof of income,” says Rudy. “The lender will likely also order a home appraisal to determine the current market value of your property.”
Step 5: Wait for approval
After submitting your home equity loan application, you’ll await approval. “The lender’s underwriting team will review all of your documents and complete some form of inspection to understand the value of your property. The lender will let you know of any next steps required during this time,” Shirshikov notes.
Step 6: Close and receive funds
Once you’ve successfully navigated the approval process of a home equity loan, you’ll enter the final stage. You will receive a closing date and instructions on where, when, and how the closing will proceed. “At closing, you will sign several documents and disclosures, and the funds will be deposited into your designated bank account,” adds Shirshikov. The lender may allow you to have funds wired to your account or issued via check.
How long does it take to get a home equity loan?
Most home equity loans take about four weeks from application to funding, though timelines vary by lender and appraisal type. Electronic valuations can take as little as one day, while full appraisals may add two to three weeks.
To avoid delays, submit documents quickly and respond promptly to lender requests.
“The largest variable is the time required for the property valuation. An electronic valuation can happen in as little as one day, but a full appraisal could take two to three weeks,” explains Jason Scott, vice president and regional relationship banking manager at Sunrise Banks.
How much can I borrow with a home equity loan?
If you qualify for a home equity loan, you can typically borrow up to 80% of the value of your home, minus any outstanding mortgage debt. That means you need more than 20% equity accrued to seek approval.
“You can use survey sites [like] Zillow to get an idea of your home’s current value and accrued equity,” suggests Michael Hausam, a mortgage broker and Realtor. Keep in mind that online estimates are not 100 percent accurate.
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Once you’ve roughly calculated your home equity value, multiply it by 80% to find the maximum amount you can borrow between your primary and second mortgages. Then subtract your existing loan balance to estimate your maximum home equity loan amount. For example:
- Home value: $500,000
- Current mortgage balance: $250,000
- Maximum total borrowing amount: $400,000 (80% of home value)
- Subtract existing mortgage debt to find your home equity loan amount
- Maximum home equity loan: $150,000 ($400,000–$250,000)
Not all homeowners can borrow the full amount of equity available. Your loan amount depends on your credit score and financial situation. In addition, withdrawing more of your equity can lead to higher interest rates.
Home equity loan requirements
You’ll need to satisfy a number of key home equity loan requirements if you want to qualify. These include having enough home equity, maintaining a reasonable debt-to-income ratio, demonstrating a good credit score, providing financial documentation, and having funds for closing costs.
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1. Sufficient home equity
An important requirement for a home equity loan is that you have enough equity in your home. The equity in your home is calculated by subtracting your outstanding mortgage balance from your property’s current market value.
To determine whether you meet the equity criteria, lenders typically use metrics such as the loan-to-value ratio (the mortgage balance relative to the value of your home) and the combined loan-to-value ratio (CLTV, which accounts for all loans on the property). Lenders typically approve home equity loans with an LTV or CLTV of up to 85%.
2. Reasonable debt-to-income ratio
When you apply for a home equity loan, lenders will look at your debt-to-income (DTI) ratio. This percentage ratio represents your monthly debt obligations divided by your gross monthly income. A lower DTI ratio typically makes you more appealing to lenders, indicating that you have a healthy balance of income and debt that will allow you to repay the loan.
3. Good credit score
A good credit score is a basic requirement for obtaining a home equity loan. A high credit score (620 or higher) indicates to lenders that you have consistently managed your credit in the past and are thus less likely to default on repayments. Here are some tips on how to raise your mortgage FICO score fast.
4. Financial documentation
Lenders will request a variety of financial documents to assess your financial situation and confirm your income. Recent pay stubs, tax returns, bank statements, proof of employment, and investment account statements are examples. You may also need the most recent mortgage statement and proof of homeowner’s insurance for any existing home loans.
Providing this documentation assists the lender in determining your financial situation and the loan’s affordability.
5. Money for closing costs
Finally, be prepared to pay closing costs, which can range between 2% and 6% of the loan amount. Some of these costs could be fees for the home appraisal, the loan origination, the title search, and the processing. Some mortgage lenders will roll these costs into the loan; however, this will increase the loan amount and possibly the interest rate.
Some mortgage lenders want you to wait up to six months after you buy or refinance before you can apply for a home equity loan. This is known as a “seasoning requirement.” However, not all lenders require loan seasoning. If you made a big down payment and have plenty of equity, you might be able to qualify shortly after buying the property.
When should you get a home equity loan?
A home equity loan can be a great option when you need to borrow a large sum of cash. Since home equity loans are a type of mortgage, interest rates are low compared to credit cards or personal loans. And you only borrow what you need, unlike a cash-out refinance, which resets your entire mortgage loan.
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There are many situations where a home equity loan makes sense. For example, you might use one to:
- Pay for an expensive renovation or home improvement project
- Pay down medical bills that you can’t afford out-of-pocket right now
- Consolidate high-interest credit card debt at a lower rate
- Finance a significant life event, such as an expensive wedding or your child entering college
Another benefit is that home equity loans typically charge fixed interest rates. This makes your repayment schedule predictable. By contrast, HELOCs usually have variable interest rates that can cause your payment to fluctuate over time.
Still, there are scenarios where a HELOC makes more sense than a home equity loan. As a revolving line of credit, a HELOC can give you a lot of financial flexibility, while a home equity loan offers a one-time lump sum. For more information, see: HELOC vs. home equity loan pros and cons.
Be aware that, when going through the steps to getting a home equity loan, your property serves as collateral to secure the loan. That means if you cannot make your payments, you could risk foreclosure.
Home equity loan rates
When deciding whether to borrow against the equity in your home, home equity loan rates are an important factor to consider. These rates frequently correlate with the prime rate, which is the interest rate that commercial banks charge their most creditworthy customers. Home equity loan rates are typically higher than mortgage rates because lenders perceive them to be riskier.
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The actual rate you receive on a home equity loan can depend on several factors, including your credit score, the loan-to-value ratio, and the prevailing market conditions.
Some lenders may offer fixed or variable rates, so it’s important to understand how these structures could impact your repayments over time. Borrowers should compare interest rates from multiple lenders to ensure they are receiving a competitive offer.
Pros and cons of home equity loans
Before deciding on the home equity loan process, it’s important to carefully weigh the pros and cons. When researching loan options, keep your financial situation, repayment ability, and long-term financial goals in mind.
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| Pros of Home Equity Loans | Cons of Home Equity Loans |
|---|---|
| Allows you to borrow a large lump sum for major expenses like home renovations or debt consolidation | Your home is used as collateral, so missed payments could lead to foreclosure |
| Fixed monthly payments make budgeting more predictable | If home values drop, you could owe more than your home is worth |
| Interest rates are typically lower than credit cards or personal loans | Closing costs and origination fees can increase the total loan cost |
| Interest may be tax-deductible when funds are used to improve the home | Increases your overall debt load, which may limit future borrowing |
Alternatives to home equity loans
Home equity loans can be a beneficial option for homeowners looking to finance big-ticket items like home renovations, debt consolidation, or large personal purchases.
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However, they’re not the only choices available. Depending on your personal finance goals, credit situation, and the amount of equity you have in your home, you might consider several alternatives. These loan options, just like home equity loans, each have unique advantages and risks that need to be evaluated carefully.
Home equity line of credit (HELOC)
A HELOC is a popular alternative to a home equity loan. Unlike the latter, which provides a lump sum, a HELOC gives you a line of credit that you can draw from as needed during a set “draw period.” The repayment period begins after the draw period ends, and the total repayment term often ranges from 15 to 30 years.
Like a home equity loan, a HELOC uses your home as collateral, but it functions more like a credit card, offering flexibility in terms of accessing your money. HELOC rates are typically variable, meaning the homeowner’s interest costs can fluctuate over time.
Cash-out refinance
Refinancing your first mortgage to tap your home’s equity is another option. In a cash-out refinance, you take out a new loan for more than you owe on your current mortgage. You receive the difference in cash and can use it for purposes like home renovations or debt consolidation. The new loan replaces your old one, and its interest is often tax-deductible, just like with your original mortgage.
Reverse mortgage
A reverse mortgage is an option for homeowners age 62 or older who want to tap their home equity without taking on monthly mortgage payments. Instead of paying the lender, the lender pays you—either as a lump sum, monthly payments, or a line of credit—while you continue living in the home.
The loan balance is repaid when the borrower sells the home, moves out permanently, or passes away. While reverse mortgages can provide helpful cash flow for retirees, they come with higher fees and reduce the equity left for heirs, so they’re best considered as part of a long-term retirement strategy.
Personal loans
If you don’t want to use your home as collateral, a personal loan could be a good alternative. While personal loans often come with higher interest rates than home equity products, they provide quick access to funds without tying the loan to your real estate property. This type of loan could be a good fit for smaller projects or immediate needs.
0% APR credit cards
Another option, particularly for smaller expenses, is to use a 0% APR credit card. Many credit card companies offer introductory periods with no interest, which can be an affordable way to finance a project, provided you can pay off the balance before the promotional period ends. It’s important to note that once the introductory period ends, the interest rate can increase significantly.
Each of these loan options comes with its own benefits and risks, all dependent on your unique situation. Therefore, understanding the loan terms, the appraised value of your property, interest rates, and your personal finance goals are all crucial when choosing the right loan product. Always consider consulting a financial advisor or mortgage professional to discuss which type of loan best suits your needs.
FAQ: How to get a home equity loan
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The timeline for getting a home equity loan after buying a house depends on building sufficient equity, typically 15-20%. With a large down payment, you might qualify immediately. In rapidly appreciating markets, you could qualify within 6-12 months. With a smaller down payment, it often takes 2-5 years. Some lenders impose a waiting period, regardless of equity.
The process of getting a home equity loan involves assessing your finances, checking your credit, and calculating your home equity. Research lenders, gather documentation, and submit your application. The lender will process your application and order an appraisal. If approved, you’ll review the offer, complete closing, and receive funds.
Yes, a home equity loan does require a credit check. Lenders use this check to assess your creditworthiness and determine your interest rate. A good credit score can not only improve your chances of approval but also help you secure a lower interest rate, which can save you money over the life of the loan.
Getting a home equity loan with bad credit can be challenging, but it’s not impossible. Some lenders may be willing to consider other factors, such as a low debt-to-income ratio, stable employment, and a substantial amount of equity in your home. However, you might face higher interest rates as a result. You could also consider bringing on a co-signer with a better credit score to improve your chances of approval.
Yes, a home equity loan generally requires an appraisal. Lenders use this appraisal to determine the current market value of your home, which, along with your outstanding mortgage balance, allows them to calculate how much equity you have in your home. This figure plays a significant role in determining the maximum amount you can borrow.
Additional resources
Looking for more information? We’ve created additional articles that explore specific options for people looking to utilize their home equity. For a deeper dive, be sure to check out the resources below.
Using a HELOC to Pay Off Credit Cards: When Does It Work?
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The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
By refinancing an existing loan, the total finance charges incurred may be higher over the life of the loan.