If you own your house and need cash, either as a one-time payment or a credit line, a home equity loan might be the answer. You will first have to take an honest look at your ability to repay, determine your home’s equity, and ultimately decide on the best type of loan and lender.
1-Look at Your Finances
A home equity loan is a second mortgage, so in addition to your initial mortgage you are going to be making another monthly payment. In the case of a home equity line of credit (HELOC) you will only be paying the interest on what you borrow for the draw period, but will have to begin making payments when the loan becomes due, essentially deferring the payments to a later date.
Can you afford to do this? Make sure to have an accurate estimate on what your monthly home equity loan payment will be and see if it fits into your budget. If you are using a HELOC to make home improvements, will those improvements likely add value to your home? If your home does not appreciate in value, or if it in fact depreciates, you are going to owe for two loans, the initial mortgage and second mortgage. This could put you in a situation where you owe more than the property is worth.
Begin your search for a home equity loan or HELOC by taking a serious, honest, and sober look at your finances. If you are unsure you can afford the added monthly expense, keep in mind if you default you could lose your home.
2- Determine How Much You'll Receive
Lenders widely vary in terms of how much they’ll give you on your home’s equity. There are those out there who will give you up to 125% of your home’s value. These are generally predatory in nature and we recommend you avoid them. Monthly payments will be high, and if you default you may end up in the horrendous situation of still owing money to the lender even AFTER you’ve lost your home.
A conservative formula a lot of lenders use to determine the amount of a home equity loan is 75%-80% of your home’s value minus what you currently owe on the first mortgage. So if your house is appraised at $350,000, and you owe $250,000, you’re looking at a ballpark figure of $30,000 for the loan or HELOC.
After you’ve performed this calculation with your own set of numbers, ask yourself if the loan amount covers whatever you are planning on using it for.
3 – Decide on the Type of Home Equity Loan
There are two types of home equity loans, straight up home equity loans and home equity lines of credit (HELOCs). Deciding which one is right for you depends entirely on the purpose of the loan.
People use home equity loans for a variety of reasons. Chief among them are making home improvements and big, one time purchases. Others include consolidating credit card debt, paying off medical bills, and paying for college tuition. If you are looking to use the proceeds to install a new roof on your house, or to pay off a set amount on multiple credit cards, the lump sum payout of a traditional home equity loan is probably right for you.
If you need access to cash over an extended period of time, you might want to go with the HELOC. Let’s say you are making a series of improvements to your house, or you are looking at continuous medical bills for the foreseeable future due to some illness, it makes more sense to have a credit line. Additionally, if you are able to pay back some of what you have already withdrawn during the draw period, you could end up using more than the original amount. Inasmuch, some homeowners take out HELOCs with no purpose at all, just to have the additional financial security.
4 - Decide on a Lender
First of all, your home equity loan does not necessarily have to be through the same lender as your mortgage. Although it is good to at least see what your current lender might offer considering the fact you already have a relationship, banks, credit unions, and online brokers are all viable options to consider. Some key factors that should influence your decision include:
- Rates – These days, a typical rate for a home equity loan is around 5.21%-5.22%, and 5.1%-5.37% for a HELOC. Keep in mind, home equity loans are generally fixed and HELOCs vary with the market. There are many different factors that will be influencing the rate you get including your location, credit, etc. In order to get an accurate quote a lender will have to take this personal information into account so know that the advertised, general rate may be nowhere near what you are going to get.
- Terms – Home equity loans typically have terms from 5-15 years. Longer repayment terms mean lower monthly payments but usually higher interest rates. Getting a shorter term is the most financially responsible option just make sure the monthly payment can fit into your budget. The HELOC term will be dictated by how long you need access to the credit line. Again, you’ll be on the hook for interest during the draw period so the longer the term the longer interest has to accumulate.
- Fees – A home equity loan has much the same fees associated with a first mortgage. Closing costs, attorney fees, mortgage insurance, application fee, appraisal fee, and penalties for missed payments could all be associated. Make sure to get an accurate picture of these fees from every lender you are considering.
If you are leaning toward a HELOC, it is also important to find out exactly how you will have access to the credit line. Will the lender issue you a credit or debit card? If the loan is for a specific project, are you comfortable with having the credit card in your wallet? Or will it be too easy to use it for other purchases other than its intended purpose. Maybe a checkbook would be a better option.
Our Top Ten List of the best home equity loan and HELOC lenders is a great place to start if you are considering going this route. You can explore a healthy mix of online marketplaces and individual lenders in order to cast as wide a net as possible.