Home Equity Loans: The Complete Guide

Learn what home equity loans are and how they work

Home equity loans can be an excellent tool to consolidate debt, pay for your child’s college tuition, or finance a home improvement project. Even borrowers with less than perfect credit can qualify for large loan amounts at competitive rates. However, there are risks to consider before you apply for a home equity loan.

Are you in the market for a home equity loan? This complete guide to home equity loans will tell you everything you need to know to tap into your home’s value.

Home equity financing

There are two types of home equity financing:

  • Home equity loans (HELs), which provide the full amount upfront.
  • Home equity lines of credit (HELOCs), which provide a credit line to draw from.

A home equity loan is a fixed-rate loan, which gives the borrower the full loan amount in a single lump sum. On the other hand, a home equity line of credit (HELOC) supplies the money as a pool of funds that you can draw from as needed.

With both types of loans, your home acts as security for the borrowed money. This collateral allows home equity loans and HELOCs to charge lower interest rates than you might find with an unsecured loan. However, it also brings added risk. If you fail to pay off your debt, you risk foreclosure on your home.

Home equity loans and HELOCs gained popularity in the early 2000s and peaked during the Great Recession.

If the current economic downturn continues, it is likely many more homeowners will consider tapping into their home equity with a secured loan.

What is home equity?

Simply put, home equity is the difference between your home’s total value and what you owe on your mortgage. For example, let’s say that your home is worth $280,000, and the balance on your mortgage is $200,000. In this case, you’d have $80,000 of home equity to borrow against.

As you would expect, home equity loans come with limits. You can’t borrow the full amount of equity in your home. In general, you can borrow up to 85% of your total home equity. Based on the above figures, the math works out as follows:

  • $280,000 total value – $200,000 remaining mortgage balance = $80,000 in home equity.
  • $80,000 x 85% = $68,000 available to borrow.

However, other factors, such as your income and credit history, are also taken into consideration when determining how much you can borrow.

Home equity loans are not as common as they were back in 2008, but they are again gaining momentum with the current lower interest rates. Home equity lines of credit are much more com

What are the pros and cons of home equity loans?

Home equity loans can be an inexpensive way to finance large purchases, such as home improvement projects or college tuition fees. However, there are some disadvantages to consider also. Here is a summary of the main advantages and disadvantages of home equity loans.

WEIGH THE RISKS & BENEFITS

Here is a list of the benefits and the drawbacks to consider.

Pros
  • You can borrow a substantial sum providing you have enough home equity to cover it.
  • According to the IRS, you can claim a tax deduction if you use the loan to “buy, build, or substantially improve your home.”
  • Because your home secures the loan, interest is usually lower than with a personal loan.
  • Generally have a fixed rate, which protects you from payment hikes.
Cons
  • Closing costs are typically much higher than with personal loans.
  • If you default on the loan, you could lose your home.
  • Less flexible than a home equity line of credit.

Finding the right home equity loan lender

Not all home equity loans are created equal. Shopping around for the best deal can save you thousands of dollars. Lenders offer radically different rates and terms, so it’s important to compare at least three offers before committing.

To find the best offer for your circumstances, the Consumer Financial Protection Bureau suggests weighing these considerations in addition to interest rates and loan limits.

When shopping around, start by identifying your goals and needs. Do you want great customer service? Do you have a borderline debt-to-income ratio? Are you looking for a low-fee or no-fee lender?

How can you find a reputable lender?

SuperMoney home equity loan comparison tools allow you to compare the rates and terms of lenders in a transparent and simple way.

In addition to researching lenders online, ask your family and friends for lenders they can recommend. Real estate agents often work with loan originators and know who helps their clients most.

Talk to banks, credit unions, nonbank lenders, and mortgage companies. You can even speak to mortgage brokers. But remember, they are in the business of arranging loans and are not always impartial.

How should you compare loan offers?

Once you’ve narrowed down your list of reputable lenders, shop around and compare loan terms and conditions. Keep an eye on the advertised annual percentage rate (APR), along with any fees and charges. And pay close attention to additional charges like:

  • Application fees.
  • Loan processing fees.
  • Origination or underwriting fees.
  • Lender or funding fees.
  • Appraisal fees.
  • Document preparation and recording fees.
  • Broker fees.

All of these fees will add to the total cost of the loan, so it’s important to take them into account when seeking the best offer.

Compare rates and terms from top lenders:

Getting a home equity loan

Before you start talking to prospective lenders, check your credit score. Your credit is a major determining factor in the types of offers you’ll receive. The better your credit, the likelier you are to lock in competitive rates and terms.

Then, you’ll want to talk to several different lenders to narrow down your options. Once you’ve put together a shortlist of offers, try asking the lenders to adjust the terms or interest rates, or to match a better offer from another lender.

Plus, keep an eye out for the following red flags, which can indicate shady or predatory business practices:

  • Changing the terms of your loan (like the interest rate) at the last minute.
  • Insisting on bundling an insurance plan into your loan.
  • Approving you for payments that are so high, you know you’ll have difficulty meeting them. Remember, if you end up defaulting, the lender will repossess your home.

Carefully read the closing papers before signing anything. If the loan isn’t exactly what you wanted, don’t sign. Leave it on the table or negotiate changes.

Can you cancel a home equity loan after committing to an offer?

Yes! The Three-Day Cancellation Rule gives you that right, free from penalties.

Set by The Truth in Lending Act (TILA), the Three-Day Cancellation Rule gives borrowers a three-day cooling-off period for second-priority mortgages, such as home improvement loans and home equity loans.

HELOCs vs. home equity loans

The second type of home equity loan is known as a home equity line of credit (HELOC). This loan works like a credit card, giving you a source of funds to draw from as needed.

Like home equity loans, HELOCs are secured by the equity in your home, and generally offer loan terms ranging from five to 15 years. But unlike a home equity loan, a HELOC is a variable-rate loan which offers a credit line in lieu of a lump sum.

Because you manage the balance of the loan, a HELOC is the more flexible option. By controlling the balance, you also regulate the interest costs, only paying interest for what you use.

Getting started

Finding the right home equity loan begins with thorough research. Click here to compare top home equity lenders side-by-side. Remember to compare at least three offers to find the best deal.