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Homeowners who want to tap into their home equity may find it a little easier now to get a home equity loan or home equity line of credit (HELOC) compared to last year. Amid the COVID-19 pandemic, many banks in the United States have announced that they are no longer offering home equity products. But with rising house prices across the country, that is about to change.
âEven though rates were low during the pandemic, getting a home equity loan was a challenge as lenders became stricter on income and property qualifications,â says Fred Glick, CEO of Arrivva, a company real estate. ” It’s better now. “
If you want to get a home equity loan or HELOC, make sure that you have acquired equity in your home, that your credit is in good shape, and that you are ready to repay the loan.
Although the names are similar, home equity loans and HELOCs are different financial products. Even if they both use your home as collateral, choosing between the two options depends on how you plan to use the funds.
Before taking out a loan on your home, it is important to understand some of the potential pros and cons. Read on to find out more.
What is a Home Equity Loan and Home Equity Line of Credit (HELOC)?
Even though the two are similar, there are some differences. Keep in mind that both can put you at risk of foreclosure if you don’t pay your lender.
Home equity loans are distributed as a one-time lump sum that you pay back to the lender with interest in fixed monthly installments. Think of it as a second mortgage on your home. Home equity loans have fixed interest rates, which means the rate doesn’t change. They may also be tax deductible, depending on how you use them.
A HELOC acts like a credit card, so you can dip into the funds whenever you need them. As you pay off the balance, the available balance is replenished. There is a draw period where you can withdraw funds, followed by a payback period where you no longer have access to the funds.
Requirements for borrowing against home equity
To borrow against the equity in your home, you must have enough equity in your home. To be eligible, you must have already paid at least 15-20% of the value of your home, for example $ 100,000 if your home is valued at $ 500,000. As part of this process, the lender will assess the value of your home, which is at your expense.
âEquity is the difference between the appraised value of the house and the total mortgage balance,â says Samuel Eberts, junior partner and financial advisor at Dugan Brown, a retirement company.
Lenders will also look at your debt-to-income ratio (DTI), which is calculated by dividing total monthly debt payments by gross monthly income. Eligible DTIs vary from lender to lender, but are typically less than 36%, which means your debt should be less than 36% of your gross monthly income. Other lenders go up to 50%. Lenders will also review credit history. Having a credit score above 700 will be sufficient to be accepted; a credit score in the mid-600s may be accepted. It is important to have a good credit rating because it will help you get a better interest rate.
To prove that you have income, be prepared to provide pay stubs and possibly W2s and tax returns.
Should You Get a Home Equity Loan or a HELOC?
Before making the decision between a home equity loan and a HELOC, it’s important to understand how much money you’ll need and for how long.
“If you are not sure how much money you need for what you are about to accomplish, take out the line of credit. [HELOC] will offer more flexibility than the loan. The downside is that interest rates can go up and you could find yourself stuck paying rates while simultaneously having to make your regular mortgage payments, âsays Eberts.
Whatever decision you make, make the payments. Since your home is being used as collateral, you don’t want to run the risk of foreclosure.
Alternatives to Home Equity Loans and HELOCs
If the idea of ââusing your home as collateral for a loan doesn’t appeal to you, there are other ways to achieve your financial goals. Here are other options:
- Withdrawal refinancing: Withdrawal refinancing involves refinancing your primary mortgage for more than you owe and receiving the difference as a lump sum. âIf you’re eligible for lower rates with a cash financing plan, this can be a great idea,â says Akhil Kumar, vice president and CCO of Arch Global Advisors, a financial advisory firm.
- Balance Transfer Credit Card: If you have good credit, you could qualify for a 0% APR balance transfer card. It gives you the option to transfer any debt to a 0% interest card, sometimes for 18 months. This gives you the flexibility to make a big purchase and pay it back over time without interest. Just make sure you pay it off before the promotional period ends or you’ll pay interest on the remaining balance.
- Credit Counseling: If you’re struggling to stay on budget and pay off debt, or have a financial goal you’d like to achieve, you can contact a nonprofit credit counseling agency for help. You will receive educational tools to help you manage your money. It allows you to take control of your own financial health and helps you make better decisions in the future. Find a credit counselor by searching the US Trustee program database here.
Can I get a home equity loan without a job?
It’s unlikely. Lenders will be wary of how you can repay the loan. âBut just because someone doesn’t have a job doesn’t mean they don’t have a source of income. Non-salaried sources of income that can get you a loan include pensions, Social Security retirement benefits, disability benefits, and investment income, âsays Eberts.
Are there any restrictions on how I can use home equity loan funds?
Funds acquired through a home equity loan or HELOC can be used for almost anything, such as buying a new car, paying for a child’s education, or taking a vacation. The funds can also be used for renovations to the individual’s primary residence.
How much does it cost to take out a home equity loan or HELOC?
The average closing cost is typically 2% to 5% of the total loan or line of credit amount. Sometimes a lender may offer HELOCs or âno-chargeâ home equity loans; However, they may have already added it to the interest charge on your loan, so always check if you are unsure. Closing costs take into account lender fees and third party services and include items such as valuation, title insurance policy, and settlement costs, among others.
Can I look for better terms and cheaper closing costs?
Absoutely. âIt’s best to shop around and compare lenders as well as things like terms and rates,â says Kumar. âPlus, if you refinance, your closing costs will often be lower. Finally, before you apply for home equity financing, if you are working to increase your credit score, you may benefit from better terms, including lower closing costs. Overall, it’s always in your best interest to research the options available before deciding which one is best for you and your family.