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What You Need to Know Home Equity Loans

What You Need to Know Home Equity Loans

Home equity loans and their similar counterparts, home equity lines of credit (HELOC’s), are popular ways for owners of property to borrow against the amount of equity they have built up in that property, which is typically a residential home. Home equity loans usually are for a fixed amount of funding, have a pre-set duration, and offer a static interest rate for the life of the loan. An example would be a loan for $50,000 at 5.5 percent interest for 10 years. The collateral for the loan is the owner’s equity in the property. Home equity loans are sometimes called 2nd mortgages.

A non-fixed rate home equity product, though not technically a loan, is called a home equity line of credit (HELOC). With these, there’s a variable interest rate and a credit limit that borrowers have access to, but don’t necessarily use, and act more like credit cards than traditional loans. 

How Do These Loans Work?

The simple process for obtaining typically includes three steps: 

  • Assess Your Current Financial Situation. You’ll need to find out your credit score and make sure that it’s at least good enough to qualify. As a very general rule, scores from the low 600’s and upward will do. Next, make an accurate list of all your income sources and monthly expenses. Determine how much you would be able to repay toward a home equity loan
  • each month. 
  • Figure Out How Much Equity You Have in Your Home. Use a third-party appraisal site to subtract the amount you still own on your home from its current value. This is a good approximation of the amount of equity you can use as collateral for the loan. 
  • Carefully Decide How Much You Need to Borrow. There are limits no matter who the lender is. A typical rule of thumb is this: The current mortgage amount PLUS the amount of the home equity loan should not be more that 80 percent of your home’s market value. There are a lot of variables in this formula and it’s important to remember that each lender has different requirements.

An Example to Determine the Amount of Equity

Your home’s market value is $300,000. Your current mortgage amount (what you still own on it) is $150,000. The amount you can borrow, when added to the amount you still own on the home ($150,000 in this example), should not exceed $240,000 (which is 80 percent of the home’s market value). The result is a maximum loan amount of $90,000. At that point, your current mortgage of $150,000 PLUS the loan of $90,000 equals exactly 80 percent of the home’s market value. 

The Bottom Line

Most borrowers can get higher or lower loan amounts depending on their credit scores, sources of income and other factors. Lenders have their own criteria, but those are the basic mechanics of getting a home equity loan. HELOCs are a different matter, require separate types of paperwork/applications, but are governed by a similar set of rules. High equity, solid credit scores, and regular income are the three keys to obtaining your desired amount.

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