Thinking about how to pay for that bathroom remodel? Do you have an unexpected home repair to make? A home equity loan may be just the thing you need. But first it helps to answer the question, what is a home equity loan? And how does a home equity loan work?
What is a home equity loan?
A home equity loan allows you to access funds by using your home’s equity. Your home’s equity is the percentage of your home’s value that you already own. It’s the difference between the amount owed on the mortgage and the value of the home. Your home’s equity can build over time as you make payments towards your mortgage or add value to your home.
How does a home equity loan work?
A home equity loan is lent in a lump sum, and you repay the amount in flat monthly installments throughout the life of the loan. The monthly payments are fixed, meaning they don’t change over time. Home equity loans can be a convenient resource for homeowners who want to access a portion of their equity.
How to calculate your available equity
A Lender will typically allow you to borrow a total of 80% of the current value of your home. If you have a 1st mortgage, you would need to combine that balance and the balance of the requested Home Equity Loan. This is known a Combined Loan to Value or CLTV. If your home is worth $400,000, the maximum you could borrower would be $320,000. If your 1st mortgage balance is $280,000 you could request up to $40,000 for your Home Equity loan.
How do I qualify for a home equity loan?
There are a few basic minimum requirements that you typically need to meet to qualify for a home equity loan, which include:
- Credit score that meets minimum requirements, which varies by lender
- Maximum loan-to-value ratio (LTV) of 80%, or 20% equity remaining in your home after financing
- Proof of ability to repay the loan
- Debt-to-income ratio at or below 43%.
What is a home equity loan used for?
There are many situations where using your home’s equity could help you stay financially secure. Some of the most common reasons to take out a loan against your home equity are:
1. Funding a home improvement project
Home improvements are one of the most common uses for home equity loans and home equity lines of credit. Home improvements can help boost the value of your current home. Home equity loans are one of the most affordable ways to remodel your home, but keep in the mind the renovation costs — they may surpass the amount of the loan.
2. Expanding the size of your home
If you’re looking to add an extra room to your home or craving more space, using your home equity can work in your favor in more ways than one. The added space may add to your current property value and can help you score some extra room without having to tap into your personal savings.
3. Consolidating your personal debt
Home equity is commonly used to pay off personal debt and help you manage monthly bills. Taking out these loans can help you consolidate high-interest debt at a lower interest rate. Paying off debt over a longer term could reduce your monthly expenses by a significant amount.
4. Starting your own business
Many people who want to start their own business may not have the funds to do so, which is why home equity loans may be an option to explore. Whether you want to start a company from scratch or open a franchise, home equity loans can help you access money that you may not have had in your personal savings account.
5. Emergency costs
Job loss, medical expenses and unexpected events can become expensive. Times like these are when home equity can be a reliable source of funds.
What not to use a home equity loan for
These loans are convenient, but also shouldn’t be used in ways that can negatively impact you. Less-helpful uses of home equity include:
1. Taking a vacation
Some people may take out loans to access some extra cash and pay for personal vacations. It may seem like it’s taking less out of your own pocket, but it could be considered debt. Using a home equity loan to finance a vacation may suggest that you’re spending beyond your means.
2. Buying a car
Buying your next vehicle using your home equity could be a risk. When you buy a car with your equity loan, this could put you at risk of losing the car if your financial situation worsens. Cars are also considered to be depreciating assets, which means their value declines over the time it’s used.
3. Purchasing luxury items
We all enjoy nice things at times, but don’t risk it all for an item that might not be worth it in the end. You shouldn’t put your home at risk by borrowing against your equity for things that you can most likely live without. For example, living within your means may result in you not buying that designer watch.
4. Investing in the stock market
You might be tempted to borrow against your home and invest in the stock market. By doing so, you take the chance of losing out on the investment and your home. Taking this risk may not be a path worth going down — the stock market isn’t always stable.
How do I apply for a home equity loan?
Applying online is a great way to start the home equity loan journey. Apply for prequalification or chat with one of our Home Lending Advisors to see what works best for your situation.
Now that you know what a home equity loan can be used for, you may want to speak with a Home Lending Advisor to figure out which type of loan best fits your needs.