If you own your home, there’s a good chance you currently have equity in the property. What does that mean? Essentially, it means that your house is worth more than you owe on it through your mortgage. With real estate prices rising across the country, it’s very likely your home has increased in value if it’s been at least a couple of years since you bought it.
Having equity in your home can be a helpful financial tool to have in your belt. You can tap into your home equity and take cash out to pay for other expenses. There are two ways to do this: either through a home equity line of credit or a home equity loan.
Each one performs a bit differently, so the best choice depends on your specific needs. We’ll briefly explain each type of home equity financing, then present five of the best online home equity lenders.
What are the best home equity loans and HELOCs?
There are many home equity loans and HELOCs out there, and some are better than others. We’ve narrowed the field to the top five lenders: Figure, LendingTree, PenFed, Bank of America, and U.S. Bank. Now find out why.
Figure
Where they’re nailing it:
- You can get approved in five minutes and get your home equity loan funded in just five days.
- Home equity loans go as high as $100,000.
- There’s no appraisal fee.
- The minimum credit score is 620, which is in the “fair” range.
Where they could improve on:
- Currently, Figure home equity loans are available in just 33 states, but more areas are being added soon.
- Origination fee ranges between 0% and 3%. Always compare loan offers to make sure the overall cost of the loan is as low as possible.
LendingTree
Why it’s one of the best:
LendingTree is a matching service that pairs borrowers with multiple lenders. Fill out a single online application with them, and you are instantly connected with multiple lenders all vying for your business.
That competition means you can instantly see who is going to give you the best home equity loan. You don’t have to scour the internet. That’s already been done. You don’t have to research the pros and cons of each loan and lender — that, too, has already been done.
Here’s what else we like about LendingTree.
- Great APR quotes.
- Their customer service is like having an infinitely patient, well-educated older brother or sister guiding you to make good decisions.
- Huge time saver. One application and you’re done.
- Everything is disclosed in plain view, and easy to understand.
- Their website is second to none.
What they can do to stay at the top:
- The phone calls can be a bit much from banks trying to get your business. A ‘do not call’ option on your account would be great.
PenFed
What’s working well:
- You can qualify for a HELOC with as little as 90% LTV.
- Credit lines can reach as high as $400,000 depending on the value of your property.
- Minimum HELOC amount is just $10,000 so you have flexibility in the amount of equity you need.
- Most closing costs are paid by PenFed.
Where there’s room for growth:
- You are responsible for the appraisal fee regardless of whether the loan closes.
- You’re required to reimburse PenFed for the closing costs they pay if you pay off the loan within two years.
Bank of America
What they’re doing right:
- With over 5,000 branches (and counting) across the United States, finding a knowledgeable person to talk to is a breeze.
- Rather talk online? B of A’s online chat service is actually handled by real live people — not algorithms spitting out planned responses after noticing a few keywords.
- Low APR quotes. 2.99% for the first 12 months — and it’s only a three-year loan.
- That’s right: a three-year loan term. (Most are five!) While your monthly payment will be higher, you’ll save more money over time with a shorter term.
- They clearly outline and disclose all fees and terms of the home equity loan. In fact, it’s one of the most transparent companies you’ll find anywhere.
Where they can improve:
- Despite their availability, customers across the board only give them an average rating on customer service.
- Their rate generator will not allow you to change the repayment period, which is unusual in the industry.
U.S. Bank
Where they shine:
- Low interest rates (fixed rates can be as low as 2.5%).
- Strong customer service reviews across the board, and the option to chat online.
- They are very transparent about every fee and term that goes along with the home equity loan. It’s right there right in the open.
- No early closing fees.
Where they need some elbow grease:
- Website is a little barren. If you’re new to the process, don’t expect U.S. Bank to take the time to help you understand.
What is a home equity loan?
A home equity loan, sometimes referred to as a “second mortgage,” allows homeowners to borrow money by leveraging the equity they’ve built in their home. This form of borrowing lets you tap into the value of your home by taking out a lump sum amount, which is repaid in fixed monthly payments over the life of the loan.
This loan type usually comes with a fixed interest rate, meaning your monthly payment stays the same over the loan term. Home equity loan rates can vary significantly among different home equity lenders, so it’s crucial to shop around and compare lenders to secure the best home equity loan.
Home Equity Loan vs. Home Equity Line of Credit (HELOC)
While both a home equity loan and a home equity line of credit (HELOC) allow you to tap into your home’s equity, they work differently.
A home equity loan provides you with a lump sum of money upfront, repaid over a set term at a fixed interest rate. On the other hand, a HELOC operates more like a credit card. It’s a revolving credit line that allows you to borrow as needed, up to a certain limit, during the draw period.
HELOCs typically come with variable interest rates, meaning your monthly payment could fluctuate based on how much you borrow and interest rate changes.
How to Calculate Home Equity
Calculating home equity is straightforward. You’ll need to subtract your existing mortgage balance from your home’s current market value. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in home equity. The more mortgage payments you make and the more your home appreciates in value, the more equity you build.
Some home equity loan lenders offer loans up to 85% of your home’s equity, depending on your credit score and other factors like your debt to income ratio. This percentage is known as the loan to value ratio (LTV). So, using the above example, if a lender offers a 80% LTV, you could potentially borrow up to $80,000.
Risks and Benefits of Home Equity Loans
Home equity loans offer several benefits, such as potentially lower interest rates compared to personal loans or credit cards, making them a viable option for big-ticket expenses like home improvements or debt consolidation. The interest on home equity loans may also be tax deductible if the funds are used to substantially improve your home, though you should consult a tax professional to understand your specific situation.
However, there are also risks associated with home equity loans. Since your home serves as collateral, failure to make timely repayments could result in foreclosure. Also, as you’re essentially reducing the equity in your home, you might end up owing more than your home is worth if property values decline.
Understanding both the benefits and risks of home equity loans is crucial before borrowing, ensuring it is the right financial tool for your specific situation.
Factors to Consider When Choosing a Home Equity Loan
Choosing the right home equity loan involves careful consideration of various factors, including interest rates, loan terms, fees, and the lender’s reputation. A well-informed decision can lead to significant savings over the life of the loan and a smoother borrowing experience.
Interest Rates: Fixed vs. Variable
One of the most critical factors to consider when choosing a home equity loan is the interest rate. The rate will significantly affect your monthly payments and the overall cost of the loan.
There are two types of interest rates: fixed and variable. A fixed interest rate means that the rate stays the same throughout the loan term, making your monthly payments predictable. On the other hand, a variable interest rate can change over time based on market conditions, which could lead to higher or lower payments.
Fixed rate home equity loans are ideal if you prefer stability and predictability in your budget, while variable rates can be a good choice if you believe interest rates will decrease in the future.
Loan Terms: Long-term vs. Short-term
The term of your home equity loan is another vital aspect to consider. This term is the period you have to pay back the loan, and it can range from a few years to several decades.
A shorter term means higher monthly payments, but less interest paid over the life of the loan. Conversely, a longer term results in lower payments, but more interest paid overall.
Choosing between long-term and short-term depends on your financial situation and how much you can afford in monthly payments.
Fees: Application Fee, Closing Costs, and Prepayment Penalties
Home equity loans often come with various fees, which can add to the overall cost of borrowing. It’s essential to ask potential lenders about all possible charges before choosing a loan.
An application fee may be charged upfront when you apply for the loan. Closing costs, which include origination fees and appraisal fees, are typically 2-5% of the loan amount. Some lenders also charge prepayment penalties if you pay off your loan early.
Make sure you understand all the costs involved before taking out a home equity loan, not just the interest rate.
Lender’s Reputation and Customer Service
Finally, consider the lender’s reputation and the quality of their customer service. Check out online reviews and ratings, and pay attention to feedback about the lender’s customer service, loan processing times, and how well they handle issues or complaints.
Ensure the lender you choose is known for their service and responsiveness, as you’ll be dealing with them for the duration of your loan. It can also be beneficial to choose a lender that offers resources to help you understand the home equity loan process, such as educational articles and loan calculators.
Remember, a home equity loan is a significant financial commitment, so taking the time to compare lenders, and understanding the terms and conditions can help you make the best decision for your needs.
Step-by-Step Guide to the Home Equity Loan Application Process
1. Evaluate Your Equity
Begin by understanding how much equity you have built up in your home. To determine this, subtract the outstanding balance on your existing mortgage from your home’s current market value. This difference gives you an estimate of how much equity is available. Remember, however, that most lenders won’t allow you to borrow 100% of this amount.
2. Check Your Credit Score
Your credit score is a significant factor when it comes to home equity loan rates and approval chances. Before applying, check your credit score to see where you stand. Most lenders have a minimum credit score requirement, often hovering around 620, though this can vary.
A higher score can not only increase your chances of approval but also get you more favorable terms and rates. If your score is on the lower end, it might be worth taking steps to improve it before applying.
3. Compare Lenders
Don’t rush into the first offer you come across. Spend time researching various home equity loan lenders, which span traditional banks, credit unions, and even online lenders. When comparing, consider their interest rates, loan terms, fees, and customer reviews.
It’s also worth noting that many lenders offer a pre-qualification process. This process provides an overview of potential loan terms you might qualify for without having a hard inquiry impact your credit score.
4. Submit Your Application
Once you’ve chosen a lender that aligns with your needs, you’ll begin the official application process. This will typically involve filling out a detailed application form. The information required often includes personal data, employment and financial information, current debts, and details about the home and the amount you wish to borrow.
5. Property Appraisal
After submitting your application, most lenders will require a home appraisal. This process ensures the lender gets an accurate and current market value for your home. An appraiser will visit and assess your home, considering factors like its condition, size, location, and comparable home sales in the area. The appraisal helps determine the amount of equity available for borrowing.
6. Loan Approval
Once the appraisal is complete and the lender reviews all your provided documents and information, they will make a decision on your application. If approved, the lender will present a loan offer detailing specific terms. This offer will include the loan amount, interest rate, loan term, and any associated fees. It’s crucial to review this information meticulously, ensuring it aligns with what you’ve discussed and researched.
7. Funds Disbursement
After agreeing to the loan terms and signing the necessary documents, the last step is the disbursement of funds. Depending on the lender, this could be a lump sum deposited into your bank account, or directly applied to any debts if the loan is for debt consolidation.
From this point on, your responsibility is to begin making the agreed-upon monthly payments based on the terms set in your loan agreement. Ensure you stay on top of these payments to avoid potential penalties and protect your home’s equity.
Required Documents and Qualifications
Securing a home equity loan involves meeting certain qualifications and providing documentation that proves your ability to repay the loan. Here’s a more in-depth look into what you might need to provide and qualify for:
Proof of Income
To assess your ability to repay the loan, lenders require proof of your income. This proof often comes in the form of pay stubs or tax returns. Some lenders might also request additional documentation, like a W-2 or 1099, or even bank statements. If you’re self-employed, you might need to provide two years of tax returns or profit and loss statements.
Good Credit
Credit scores play a crucial role in lending decisions. They serve as a measure of your financial reliability. Most lenders require a minimum credit score (typically around 620), but the specific requirement can vary.
The higher your credit score, the better the terms and interest rate you can secure. If your score is low, consider ways to improve it, such as paying off outstanding debt or correcting any errors on your credit report.
Debt-to-Income Ratio
The debt-to-income (DTI) ratio represents the portion of your income that goes toward paying debts each month. This ratio helps lenders gauge your ability to manage monthly payments and repay the loan.
Most lenders prefer a DTI of 43% or less, although some may accept higher ratios in certain circumstances. To lower your DTI, you might consider paying down existing debts before applying for a home equity loan.
Appraisal
Lenders will require a home appraisal to accurately determine the current market value of your home. This process typically involves a professional appraiser visiting your home and assessing its size, condition, location, and comparable homes in the neighborhood. The result of the appraisal not only determines your home’s value but also the amount of equity you have available to borrow.
Equity
Equity refers to the portion of your home you truly “own” — that is, the value of your home minus any outstanding mortgage balance. Most lenders require you to have at least 15-20% equity in your home to qualify for a home equity loan.
However, keep in mind that most lenders also cap the total loan-to-value ratio (existing mortgage plus the home equity loan) at around 80-85%. That means you won’t be able to borrow the full amount of your available equity.
Strategic Use of Home Equity Loans
Home equity loans can provide a significant amount of capital, making them an excellent tool for specific financial needs. Here are some strategic ways to use a home equity loan:
Home Improvement
Investing in your home can be a wise use of the funds from a home equity loan. Whether it’s for necessary repairs, a significant renovation, or upgrades to increase your home’s value, using your home’s equity can be a financially smart way to fund these projects.
Besides, the interest you pay on the loan might be tax deductible if the loan is used to “buy, build or substantially improve” the home that secures the loan, according to the IRS.
Debt Consolidation
If you’re dealing with high-interest debts like credit cards or personal loans, using a home equity loan for debt consolidation can be a strategic move. The reason? Home equity loans typically have lower interest rates than these types of debt.
By consolidating, you could potentially reduce the amount you pay in interest over time, making your debt more manageable and predictable with one fixed monthly payment.
Emergency Fund or Large Purchases
While it’s not recommended to borrow more than necessary, a home equity loan can be a lifeline in case of a financial emergency or for significant, planned expenses. These can include unforeseen medical bills, tuition payments, or even starting a business. Just remember, your home is the collateral for the loan. It’s important to have a solid plan for repayment to avoid risking your home.
Common Mistakes to Avoid When Using Home Equity Loans
While a home equity loan can be a powerful financial tool, improper use can lead to a precarious financial situation. Here are some common mistakes to avoid:
1. Borrowing More Than Needed
It’s tempting to borrow more than you need when you have access to a substantial amount of money, but it’s a trap that can lead to long-term financial strain. Remember, a home equity loan isn’t free money — it’s a debt that comes with interest and fees. Borrow only what you need to avoid unnecessarily high monthly payments and to keep the total cost of the loan down.
2. Ignoring the Fine Print
The terms and conditions of your loan hold important information, including the interest rate, repayment terms, and fees associated with the loan. This includes origination fees, appraisal fees, and potentially prepayment penalties if you pay the loan off early. Ignoring this information could lead to unpleasant surprises down the line. Make sure to thoroughly understand the terms of your loan before signing.
3. Forgetting About the Risks
It’s essential to remember that your home is the collateral for a home equity loan. If you fail to make your payments, you risk losing your home. This makes the decision to take out a home equity loan a significant one that should not be taken lightly. Ensure you have a solid plan in place for repayment before you borrow.
Always seek advice from a financial advisor or a trusted financial institution before deciding on a home equity loan. Being well-informed can help you avoid these common pitfalls and ensure that your home equity loan aligns with your financial goals.
Conclusion
Home equity loans can be a useful tool in managing your financial situation, particularly when it comes to large expenses or consolidating high-interest debt.
In choosing a home equity loan, it’s essential to consider the interest rates, loan terms, and fees. Also, your credit score and debt-to-income ratio significantly influence the terms and rates you’ll receive. Make sure to shop around and compare lenders to get the best deal possible.
Remember, borrowing should be done strategically. Use home equity loans for purposes like home improvements, consolidating debt, or for significant, necessary purchases. Always avoid borrowing more than necessary, ignoring the fine print, and forgetting about the potential risks.
