Home Equity Loan And HELOC Guide - Bankrate.com

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We are an independent, advertising-supported comparison service. Our goal is to help you make smarter financial decisions by providing you with interactive tools and financial calculators, publishing original and objective content, by enabling you to conduct research and compare information for free – so that you can make financial decisions with confidence.
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If you need cash for a home renovation or other large expense, you may be considering tapping into your home equity for funding. Two of the main ways to do that are home equity loans and home equity lines of credit (HELOCs).
Borrowing using your home equity as collateral could be a great strategy for many U.S. homeowners. The average homeowner had about $153K in home equity that they could tap into before reaching the common limit of 80% loan-to-value ratio (LTV). If you are thinking about borrowing using a home equity loan or HELOC, make sure you know the differences between the two so you can decide the best option for you.
Also known as home equity loans or second mortgages, equity loans are loans that allow borrowers to borrow money by tapping into their home’s equity, or the value difference between the current market value and their remaining mortgage balance. Equity loans come in two forms: Home equity loans and HELOCs. In both, your equity acts as collateral for the lender, so if you fail to make the monthly payments, you run the risk of losing your home.
Generally, the total amount you can borrow is based on loan-to-value ratio (LTV) — how much you’re borrowing divided by the value of the property —  with a typical limit of 80 percent of your equity. However, the amount you’ll be granted is based on factors such as credit score, annual income and payment history.
Home equity loans operate similarly to a second mortgage and come with fixed, monthly payments. These loans can be used for things like home improvement projects, financing a college education, debt consolidation or long-term investments. HELOCs are lines of credit, making them useful for larger, long-term home improvement projects and typically come with a variable interest rate, but some lenders may offer fixed-rate options.
Equity loans are useful if you have equity in your home and use it to finance a project that will increase the value of your home in the long run, or if you want to consolidate high-interest debt.
While the eligibility criteria will likely vary depending on the lender, there are some general requirements that most lenders require. Here’s a list of standard requirements:
A home equity loan is a secured loan that is backed by your home’s equity. They almost always come with a fixed repayment term between five to 30 years and a fixed interest rate that’s based on your financial history. Home equity loans are funded in one lump sum and can be used to finance any project, investment or purchase.
Over the course of your loan, if your credit score improves due to making the monthly payments in full and on time, your interest rate could be lowered, and if used to substantially increase the value of your home, the interest may be tax-deductible.
A home equity line of credit is an equity loan that operates as a line of credit and is similar to a credit card. You can borrow up to a certain amount and take out however much you need when you need it. With a HELOC, you’re not locked into a set repayment period and can make the payments when you withdraw funds. The interest rates are generally variable, but some lenders may offer fixed-rate options.
HELOCs have a draw period of 10 years and a repayment period that lasts typically between 10-20 years. During the draw period, you’re only required to make interest payments and can access the funds. During the repayment period, you can’t access your funds and are responsible for making both the interest and principal payments.
Home equity loans can seem similar to HELOCs, but they are different ways to borrow money from your home’s equity. Here are some of the key differences between home equity loans and HELOCs.
 
If you have a solid, steady income, a healthy credit history and are in good financial health, tapping into your home’s equity can be a convenient way to get the cash you need with lower interest rates.
Because home equity loans are secured and backed by your home, they often come with lower interest rates than unsecured forms of debt, like credit cards or personal loans. It’s also common to use home equity loans to consolidate high-interest debt, as the low rates can save you money in interest in the long run.
Be careful when using your home equity. It’s generally best to use your home equity for costs that improve the value of your home long-term, like home renovations or additions. Be careful if you want to use a home equity loan for expenses like going on vacation, buying a car, or paying for school because these won’t add value to your home. You could lose your home if you are unable to pay back your borrowed funds.
Due to the Tax Cuts and Jobs Act of 2017, whether or not you can deduct the interest charges depends on when you took out the loan, how much you borrowed and how you used the funds. To deduct the interest charges from your taxes, the loan must be used to “buy, build or substantially improve” the home backing the loan.
Joint filers that borrowed from their home’s equity after Dec.15, 2017, can deduct interest up to $750,000, and separate filers can deduct interest up to $250,000 worth of qualified loans. For joint filers that took out their home equity loans before Dec.15, they can deduct up to $1 million, and separate filers can deduct up to $500,000. These limits also apply to current mortgage loans as well, so if you have a current mortgage loan, this will cut into how much you’re able to deduct.
When you refinance, you take out a new mortgage loan that replaces your previous mortgage. Most borrowers refinance to score a lower interest rate or new terms, so it only makes sense to refinance if you’re offered a lower interest rate or a loan with better terms. You’re not responsible for paying off the first mortgage; the new lender will, and you’ll continue to make the loan payments as scheduled, just with a new lender.
Refinancing is also referred to as a rate-and-term refinancing or a cash-out refinance. Here’s the difference between the two:
Both refinancing and home equity loans are ways to get the funds you need through tapping into your home’s equity, but refinancing and home equity loans are used in different situations. Here’s when to consider refinancing, and when to take out a home equity loan.
Refinancing is best for borrowers who:
Home equity loans are best for borrowers who:

Here are 4 steps to follow when applying for a home equity loan:
Before applying, make sure you know your credit score and check your debt payment history. If you have less-than-stellar credit and frequently miss payments, it will be harder for you to get approved. To increase your chances of approval, take steps to improve your credit score and if possible, improve your payment history by at least making the minimum payments on your current mortgage and debts.
Also calculate your debt-to-income ratio (DTI). If you have a DTI higher than 50 percent (at the most), it will be difficult to get approved for an equity loan. Focusing on paying down existing debt will lower your DTI, improve your credit score and improve your payment history.
To qualify for most equity loans, lenders will require you to have at least 20 percent equity — a maximum of 80 percent LTV– in your home to be eligible for approval. Before applying, calculate your LTV ratio by using a calculator, or by dividing the appraised value of your home by your current mortgage balance.
Before applying, consider the potential risks associated with an equity loan. If you default on your loan, you could lose your home to the bank. Conduct an audit of your financial situation, and look at your previous payments. How well are you at keeping up with your mortgage payments?
If you’re not on top of your monthly payments or have trouble keeping your payments organized, talk with a financial advisor to help you decide whether or not a home equity loan is too risky for your personal financial habits.
Compare equity loan lenders by shopping around to find the most competitive rates and terms for your financial situation. Once you find the lender that meets your needs and offers the best rates, check the eligibility requirements to make sure you qualify. Then you can start the application process, which can be done online or in-person if financing through a bank or credit union.
To ensure a smooth application process, make sure you’re familiar with the required documentation and that you have what you need during the application.
If you’re having trouble making your monthly equity loan payments, contact your lender as soon as possible before defaulting on your loan. Once you default, that’s when you risk losing your home, and some lenders may offer forms of relief like lowered interest rates, adjusted repayment terms or forbearance options. While this isn’t a given for every lender, it’s worth checking before your loans enter into default status.
Once your loans have entered into default status, your lender will constantly reach out to you via phone calls, letters or emails. If you receive a notice, reach out immediately. There’s a chance that the lender may be willing to adjust your loan or repayment term if you can prove that you’re now able to make the monthly payments.
Here are some resources to help you navigate the confusing process of borrowing a home equity loan:
Here are some resources to help you navigate the confusing process of taking out a home equity line of credit:
While borrowing from your home’s equity can be a risky move, it can pay off in the long run if you’re dedicated to making the payments. Equity loans are great ways to borrow large sums of money for lower interest rates and can provide substantial long-term benefits.
If you’re unsure whether to borrow a HELOC or a home equity loan, conduct a financial audit to determine which equity loan works best for you. Research the risks and benefits before applying, and compare lenders to find the most competitive rates for your situation.
You may also want to speak with a financial advisor to help determine which option best suits your financial situation.
Bankrate.com is an independent, advertising-supported publisher and comparison service. Bankrate is compensated in exchange for featured placement of sponsored products and services, or your clicking on links posted on this website. This compensation may impact how, where and in what order products appear. Bankrate.com does not include all companies or all available products.
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