Home equity loans Vs. a Cash-out mortgage refinance
A home equity loan operates much like a second mortgage. You borrow a lump sum that you repay over a fixed term at a fixed interest rate. This option is ideal if you have a large, one-time expense, like a home renovation or a wedding. It's also suitable for those who prefer predictable monthly payments.
On the other hand, a cash-out mortgage refinance involves replacing your existing mortgage with a new one for more than you currently owe. The difference is paid out to you in cash. This method is commonly used for consolidating high-interest debts, such as credit cards, as the interest rates are typically lower than those for unsecured loans, and the interest may be tax-deductible.
A cash-out mortgage refinance may be a better option if you can secure a lower interest rate than your current mortgage, which could save you money over the life of the loan. Additionally, it could be advantageous if you need a substantial amount of cash, since it's usually possible to borrow more money through a refinance than with a home equity loan.
However, remember that refinancing comes with closing costs, which can total 2% to 5% of the loan amount. Always factor in these costs when considering whether to refinance.
How does a home equity loan work?
A home equity loan is a type of secured loan in which homeowners borrow a certain amount of money against the equity of their home. The loan is then repaid over a fixed period of time, anywhere from 5 to 20 years. It can be used to pay for things like college tuition, medical expenses, or even just to make some improvements to your house.
Home equity loans usually have a lower interest rate than other types of loans because it's backed by collateral — your house. And because home equity loans are less risky for lenders compared to unsecured loans, they can offer you a lower interest rate as a result.
However, it’s important to remember that if you can’t make your payments, you could lose your home. So make sure you can afford the monthly payments before you take out a home equity loan.
Today's average interest rates for home equity loans
The table above shows the range of rates offered by leading home equity loan providers. However, these ranges tend to be pretty wide, which means they are only good as a very rought guide of the rates you can expect to get. The only way to know if a lender is a good fit for a home equity loan is to get an offer. That is the only way you will know what rates and terms you really qualify for.
We recommend applying for a home equity loan with three to five lenders and comparing rates and terms. Then compare your best offer with other products, such as shared equity agreements, cash-out mortgage refinance, home equity lines of credit and reverse mortgages.
The overall cost of a home equity loan
The overall cost of your loan can vary quite a bit depending on the home equity lender. In general, borrowers may be expected to pay extra fees at closing or throughout the life of the loan. Some of these costs include:
- Origination fee to initiate the loan.
- Closing costs such as home appraisal fees and credit report fees (2% - 5% of total loan amount).
- Fees for late monthly payments.
- Prepayment penalty for paying off the loan early.
How to calculate your home's equity
Your home equity is the market value of your home minus any money you still owe on your mortgage. To calculate it, simply subtract the balance of your mortgage from the current market value of your home. This number tells you how much money you would have left if you sold your house right now and paid off your mortgage.
For example, if your home is worth $200,000 and you still owe $100,000 on your mortgage, then your equity is $100,000. If your home is worth more than the amount you owe on it, your equity will be a positive number. Conversely, if your home is worth less than what you owe on it, your equity will be a negative number.
Keep in mind that your equity can change over time. If the market value of your home goes up, your equity goes up too. And vice versa. So it's a good idea to keep track of how much equity you have in your home at all times.
Best uses for a home equity loan
The funds from your home equity loan can be used however you like. But it's worth mentioning that borrowing against your home for luxury items such as a fancy car or a designer bag can be a very bad idea. Make sure to only tap into your home equity for necessary expenses like:
When you're hit with a major unexpected expense, it can be tough to know where to turn for money. You might not have enough in your savings account to cover the cost, and taking out a loan from a traditional lender could mean paying high-interest rates. This is where a home equity loan could come in handy.
Taking out a home equity loan to consolidate debt
can be a great way to get your finances in order. By taking out a single loan to pay off all of your other debts, you can reduce the amount of interest you're paying each month and make it easier to keep track of your payments. In addition, by consolidating your debt into one monthly payment, you may be able to improve your credit score.
Funding college education
A home equity loan can provide you with much-needed funds to cover tuition and other expenses for education. Moreover, a home equity loan typically has a lower interest rate than other types of debt, making it an affordable option compared to private student loans.
By borrowing against the equity in your home to fund your renovation, you can get a lower interest rate than you would on a personal loan or credit card. Also, the interest payment on a home equity loan is usually tax-deductible
if you use the funds for home renovations.
By tapping into the value of your home, you can borrow money at a low-interest rate to invest in other assets such as stocks, bonds, or real estate. This can be a more affordable option than taking out a loan from a bank or other lending institution. And by investing in assets that have the potential to appreciate in value over time, you can potentially increase your net worth and secure your financial future.
Of course, home equity loans are not the only game in town. There are other ways to tap into your home equity, such as shared equity agreements
and home equity lines of credit
Pros and cons of home equity loans
Home equity loans are great financing options for homeowners in need of large sums of cash. However, it can also come with some risks and disadvantages.
How to apply for a home equity loan
The majority of home equity loan lenders will let you begin the application process online by simply entering your personal and financial details. Depending on the loan amount and other financial factors, you may be asked to provide additional info.
Here are some examples of documents and information that are typically required:
- Social security number
- Government-issued ID
- Last two personal federal tax returns
- Last two W-2 statements
- Most recent pay stub
- Proof of ownership of the home
- Most recent mortgage statement
- Home insurance declarations page
- Appraisal of your home
The process of getting approved for a home equity loan is similar to the approval process from a primary mortgage lender. To qualify, home equity lenders typically require that borrowers have a:
- A debt-to-income ratio of 43% or less.
- A minimum credit score of around 620.
- Home equity of at least 15% to 20%.
To calculate your home equity percentage, simply divide your home equity by the appraised value of your home. For example, if you have a $200,000 home with a $150,000 remaining mortgage balance, your home equity would be $50,000. So, your home equity percentage would be 25% — $50,000 divided by $200,000.
The amount of money you can borrow with a home equity loan depends on the value of your home and how much debt you have on it. Most lenders will only allow you to borrow a maximum of 80% to 90% of your home equity.
Let's say your home currently has an appraised value of $500,000 and you still have a $250,000 mortgage that's not yet paid off. This means your home has a total of $250,000 in equity and your borrowing limit should be anywhere around 80% to 90% of that, which is equal to $200,000 to $225,000.
What to consider before applying
Borrowing against the equity in your home is a big decision that should not be taken lightly. Make sure you've thought carefully about it and have taken your financial ability into consideration.
- Take financial inventory. Before you take out a home equity loan, it's important to take stock of your financial situation. This means reviewing your expenses and income, as well as your assets and liabilities. By doing this, you'll have a better understanding of how much money you can afford to borrow. You'll also be able to identify any potential problems that could arise if you take on more debt.
- Determine how much you're comfortable borrowing. When it comes to home equity loans, there's no one-size-fits-all answer. The amount you're comfortable borrowing depends on your personal financial situation and goals. Before taking out a home equity loan, it's important to determine how much debt you can comfortably afford to take on. This will help you avoid becoming overextended and risking your financial stability.
- Consider your ability to repay on a monthly basis. It's important to remember that borrowed money needs to be repaid with interest, so make sure you can afford the monthly payments. Moreover, when you take out a home equity loan, you're putting your home at risk if you can't make the payments. So if you're unsure about whether borrowing against your home is right for you, talk to a financial advisor for more advice.
Home equity loans vs. HELOCs
When it comes to borrowing from your home equity, there are a few different types of loans that you might be able to get. Two of the most common ones are home equity loans and HELOCs
. Here’s a look at the differences between these two financing options:
Home equity loans are just what they sound like – loans that are taken out against the equity you have in your home. It provides you with a one-time lump sum payment and allows you to borrow a large amount of cash with relatively low interest. HELOCs, or Home Equity Line of Credit, work more like a credit card. Funds can be withdrawn during a so-called draw period. And during this period of usually 10 years, you can withdraw as much as you want up to your total available credit line. When the draw period ends, you'll have to repay the amount you took out.
Another key difference between the two is that a home equity loan has a fixed interest rate, which means fixed monthly payments. Home equity lines of credit, on the other hand, have variable interest rates. This means that the rate of interest can change at any time, depending on market conditions.
So, which one is right for you? It depends on your financing needs. A home equity loan is good if you need a large sum of cash all at once. But if you only need a small amount of money from time to time, a HELOC may make more financial sense for you.
Ways to reduce your home equity loan closing costs
Reducing your home equity loan cost can have a great impact on your financial future. The less money you have to pay back each month, the more money you can save in the long run. It could also free up more cash flow which you can use for other purposes. So here are some tips to help you reduce your total loan amount.
Shop around and negotiate
The total cost of a home equity loan can vary quite a bit from one lender to the next. By shopping around and doing research, you can save yourself hundreds — or even thousands — of dollars in interest payments over the life of your loan. And don’t forget to negotiate. Many lenders are willing to negotiate the terms of their loans, including the interest rate. So don’t be afraid to ask for a better deal.
Demonstrate you're a creditworthy borrower
Lenders will typically give you a lower interest rate if they know you have a good history of borrowing money and repaying it on time. To demonstrate to lenders that you're a creditworthy borrower, it's a good idea to establish a track record of good borrowing behavior before applying for an equity loan. For example, you can improve your credit score by paying bills on time, not exceeding your credit limit, and catching up on past-due accounts.
Borrow only what you need
The easiest way to lower your total home equity loan cost is to not be tempted to take out more money than you need. This way, you won't have to pay as much in interest. Plus, you'll be able to get your home equity loan paid off sooner. This may sound like obvious advice, but it's still important to keep in mind.
Frequently asked questions about home equity loans
Can you get a home equity loan with bad credit?
Having a bad credit score means you might have more difficulty getting a home equity loan, but it’s not impossible to qualify. Not all lenders have the same standards and requirements, so be sure to do your research before applying. If your credit is quite poor and you can’t qualify for a loan on your own, applying with a co-signer may be helpful.
Keep in mind that your interest rates might be much higher than those with good credit. So be sure to compare interest rates from different home equity lenders. This will help you find the best deal. And remember, as with any loan, it's important to read the terms and conditions carefully before signing on the dotted line.
Where can you get a home equity loan?
There are many different ways to get a home equity loan, and the best option for you will depend on your individual circumstances. But you can usually find home equity loans offered by online lenders or financial institutions such as credit unions and banks.
Be sure to ask about any hidden costs, such as origination fees or prepayment penalties. By doing your research, you can find the best deal for your needs.
How fast can you get a home equity loan?
How fast you can get a home equity loan will mainly depend on factors such as your income level, credit score, and debt to income ratio. But usually, it should take anywhere from 2 to 4 weeks. Keep in mind that a low credit score might delay the process since additional paperwork may be required.
What are some alternatives to a home equity loan?
Home equity loans might not be for everyone. Here are some alternatives to help you still get the financing you need.
- Cash-out refinancing. Cash-out refinance is a process where you take out a new loan to pay off your old one, and keep the difference between the two loans as cash. One key advantage of cash-out refinancing is that you might end up with a lower interest rate if mortgage rates were higher when you originally bought your home.
- Reverse mortgages. A reversed mortgage is a special type of home loan that allows homeowners over 62 to borrow against the equity in their homes without having to make loan payments. Borrowers can receive the funds as a lump sum, fixed monthly payment, or line of credit.
- Fixer-upper loans. A fixer-upper loan is a type of mortgage that allows the borrower to purchase a property in need of repair. The repairs can be extensive, or simply cosmetic, and the loan amount will be based on the estimated value of the property once the repairs are complete.
- Personal loans. If you don't have equity in your home or prefer to not touch it at all, then it might be worth considering personal loans instead. Personal loans are also sometimes referred to as signature loans because they’re approved based on the borrower’s signature alone, rather than on the value of the assets being offered as collateral. However, this could also entail higher interest rates.
Are home equity loan interest rates higher than mortgage rates?
Yes, home equity loan interest rates are typically higher than mortgage interest rates. Because home equity loans are considered second mortgages, they are lower in priority in the event of a foreclosure. This means that home equity loan lenders will be paid only after mortgage lenders have been paid in full.
As a result, home equity lenders have to charge higher interest rates to make up for this risk.
Is it worth getting a home equity loan?
Is a home equity loan worth it? Ultimately, that’s up to you to decide. On the one hand, a home equity loan can be a great way to get access to cash quickly in an emergency. On the other hand, if you don’t repay the loan according to the terms set out in your contract, you could lose your home. But overall, it could be worth it if you weigh all the pros and cons carefully and only take out what you can afford.
Does a home equity loan impact your credit?
Yes, taking out a home equity loan could negatively impact your credit score by a few points in the short term — mainly due to the large increase in outstanding debt on your credit report. But don't worry. Usually, by making on-time monthly payments on your home equity loan, you should expect to see your credit score return to its pre-loan level and even surpass it.
However, if you don't make your loan payments on time, it can cause your credit score to drop. This can make it more difficult for you to get approved for future loans or lines of credit. And may even increase the interest rate you pay on those loans.