What Are Home Equity Loans And How Can You Take It – A Complete Guide In 2021

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Home Equity Loans

Are you planning to apply for a home equity loan? This guide includes the basics of home equity loans, their pros, and cons. Additionally, you will also learn how to apply it and some frequently asked questions regarding home equity loans.   

When it comes to borrowing money, people search for different ways to get a loan. No matter why you need money, there are several options available to apply for a loan. Among different options, a home equity loan is one of the easiest ways.

Home Equity Loans Explained

Home equity loans are also known as equity loans that you can borrow against your equity in your home. The amount of loan depends on the difference between the market value of your home and the mortgage balance due. 

Usually, home equity loans interest rates are fixed, but home equity lines of credits (HELOCs) may have variable interest rates. Fixed interest rates and variable interest rates have their own advantages and drawbacks. You should weigh the pros and cons of both options before choosing a method. Now, take a look at how they work. 

How Do Home Equity Loans Work?

Home Equity Loans Work

Home equity loans work like a mortgage. Hence, it’s also known as the second mortgage. When you apply for a secured loan, the lender needs collateral to lend you. In the case of heme-equity loans, the lender considers your home equity as the collateral. You need to understand the following terms to know how a home equity loan works. 

  • Appraised Value: It’s the estimation of the value of a property at a given point in time. 
  • Combined Loan to Value Ratio: It is the ratio used for lending money to a borrower. It’s the ratio between all the secured loans on a property to the total value of the property. Some lenders allow you to get home equity loans when your CLTV ratio is more than 0.8 to 0.9. 

Although CLTV plays an important role, your credit score and payment history also matter a lot for your borrowing potential. 

Some Important Factors About Home Equity Loans

Factors About Home Equity Loans

Before you apply for home equity loans, here are some important factors you need to consider.

  • Just like any other mortgage, home equity loans also have repayment options. The repayment value includes both some percentage of the principal and some percentage of interest. If you fail to pay the debts or default on the debt, the lender will seize your equity. 
  • Home-loan equity is a good way to convert your equities into cash. It’s more beneficial if you use that cash to renovate your house. However, you should be aware of the real estate market before making the investment or apply for these loans. 
  • Before you apply for a home equity loan, you need to know about the tax regulations of your state to avoid any kind of disputes in the future. 

Now, consider the pros and cons of home equity loans before you apply for them. 

Pros Of Home Equity Loans

These are some of the benefits of home equity loans if you are a responsible borrower. 

  • It’s one of the best ways to get loans at low-interest rates, and you can save from lower tax deductions.
  • Home equity loans are also simpler for some consumer debt because it’s a secured. So, the lender easily approves your loan. 
  • The interest rate is lower than credit card interest and other types of consumer loans except for first mortgage loans. 
  • They can help you borrow large amounts of money at a time. 

Cons Of Home Equity Loans

Now that you know about the benefits of home equity loans, here are some of the drawbacks: 

  • Since they offer you to borrow large amounts, you may tend to borrow more than you need. 
  • As home equity loans seem an easy-option, you may also be tempted to borrow a loan even if you actually need it and fall into a habit of debt-cycle. 

Now that you know about the pros and cons, weigh them judiciously before applying for a loan. 

Frequently Asked Questions (FAQs) On Home Equity Loans

Here are some frequently asked questions regarding home equity loans. You can read them to get more clarity before applying for a home equity loan. 

What Is The Downside Of A Home Equity Loan?

Home equity loans are more expensive than a first mortgage loan and home equity line of credits. However, you should also consider that a home equity line of credits has a variable interest rate. If the interest rate falls, that’s your benefit, but if the price rises, you may have to pay high repayments. 

How Do You Qualify For A Home Equity Loan?

Here are some common conditions to qualify for a home equity loan.

  • If you have a credit score of 700 or more, you can easily qualify for a home equity loan. 
  • Your maximum LTV ratio should be more than 80%. 
  • The debt-to-income (DTI) ratio should not exceed 43%. 
  • If your documents (repayment history) show that you can repay your loans, you are qualified.  

What Credit Score Do You Need To Get A Home Equity Loan?

Although you can easily get a home equity loan if your credit score is above 700, the minimum value to be eligible for home equity loans is 620. If your credit score lies between 620-680, you can qualify for a home equity loan. 

How Much Can You Borrow From A Home Equity Loan?

The amount of a home equity loan depends on your creditworthiness, repayment history, and outstanding debt. Depending on those factors, you can borrow around 85% of your home equity’s appraisal value. 

Final Words

Home equity loans can help you get a large amount and achieve your big dreams like renovating your house or fulfilling other financial goals. Although lenders check your combined loan to value ratio, they also consider your credit score and history.

So, if you want to borrow against your equity in homes, maintain a good credit score as well. Lastly, please don’t hesitate to consult a financial advisor if you need professional help for managing your wealth.

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