Get a Home Equity Loan

A home equity loan is often considered a second mortgage and is based upon the equity in the property, or the difference between market value and any existing mortgages/loans against the house.[1] Since houses, like all assets, constantly vary in market value, the amount of equity in a home constantly changes. A home equity loan is given in a lump sum and used for major expenses, such as paying for college, medical expenses, or major home repairs, using your house as collateral. A home equity loan usually has a fixed term of repayment and a higher interest rate than a mortgage, but rates are lower than the rates on credit cards and other loans, and payments are often tax-deductible.[1] If you're considering a home equity loan, you'll need to determine the equity of your home and find a reputable lender who will offer you a fair, affordable loan.

Steps

Considering the Risks

  1. Determine what you will use the money for. A home equity loan can be used for home repairs and renovations, medical bills, college tuition, credit card debt, or any other unexpected expenses. Your lender will give you a lump sum of money with a fixed interest rate and definite repayment period. Because a home equity loan is a lump sum of money, it is best used for a specific expense (e.g. adding a room to your house, remodeling a bathroom, etc.).[2]
    • If you need money over time or just want some financial security, a home equity line of credit (HELOC) may be a better choice. You can withdraw money as you need it and are only required to pay back what you actually use.[3]
    • A home equity loan has a fixed interest rate, and a HELOC has variable interest rates. Your payments could change drastically with a HELOC.[2]
    • HELOC is similar to a revolving line of credit through a credit card or bank. Your monthly payments will depend on what you have borrowed and the current interest rate.
  2. Review your financial situation. Before you borrow against your home, make sure you are in a financial position to repay the loan. Write down all of your living expenses (e.g. food, mortgage, car payments, etc.), income, debt, and financial goals. Home equity loans are only beneficial if you can afford to pay them back.[4]
    • If you are unable to pay the loan back, you may end up in more debt than before you had the loan.
    • If you are using your loan to fund home improvement, make sure the added value to the home is worth taking out the loan.
    • The lender will generally be looking at your cash flow when determining a loan amount and an interest rate. Lenders generally do not want to go through the expense and trouble of foreclosing on a defaulted loan. They know that if borrowers have no equity in a property (the total loans equal or exceed the property’s market value), they are more likely to default and walk away.
  3. Factor in the additional costs. Be prepared to pay fees and closing costs when you take out your loan. The potential fees are to cover the home appraisal (if required by the lender), application, title search, document preparation, and an attorney or title agent. These fees apply to both home equity loans and HELOCs. There may be additional fees with a HELOC such as annual membership fees or transaction fees for each time you take out money. Talk to your lender about the possibility of waiving a portion of or all of the closing costs.[3]
    • Keep in mind that a home equity loan is still a mortgage. The interest rate is likely to be higher than your first mortgage, but the closing costs will be lower than your original mortgage.[5]
  4. Determine how much equity you have in your home. You can calculate your home equity by subtracting the amount your house is worth from the amount you still owe on the mortgage. For example, if your your home is currently valued at $200,000 and you owe $100,000, your equity would be $100,000. Knowing your equity will prepare you to discuss your loan terms with potential lenders.
    • Remember that market value fluctuates, so your equity is not a constant. Consider that most lenders expect a maximum loan amount equal to 80% of the market value. For example, if the market value is $200,000, lenders typically will loan up to $160,000 maximum.
  5. Decide how much you need to borrow. Lenders use a formula to decide how much your loan will be. They typically take 75%-80% of your home's value minus the amount you still owe. Some lenders may offer to lend you more than the standard range and may even go up to 100% or 125% of your home's value. However, it may not be not advisable to take out a loan this large.[2]
    • If you try to sell your home and the value of the home has not appreciated yet, you may end up having to pay on the loan once you have sold your house.
    • Loans larger than the value of your house also come with higher fees. Interest paid on the portion of your loan that is more than the value of your home is not tax deductible either.
    • The deduction of interest paid on home equity loans may be limited based upon the maximum loans secured by the property, the date such loans were initiated, and the amount of interest paid.

Shopping for a Loan

  1. Talk to multiple lenders about home equity loans. It is important to shop around and get the best deal that you can. Your home equity loan does not have to be through the same lender as your current home loan. Banks and credit unions are a good place to start. Credit unions usually have better rates than banks and other types of lenders.[2]
    • Compare interest rates, fees, monthly payments, penalties for missed payments,and the length of the loan terms.
    • Ask about waiving or discounts on additional fees and closing costs.
    • Shopping around is important, but also consider your mortgage lender. They may be willing to give you a good rate because you are a current customer.
    • Feel free to let each lender know that you are shopping around for the best deal.
  2. Avoid predatory lenders. Use good judgment when you choosing a lender. Stay away from lenders who encourage you to take out more than you can afford (e.g. 90% or 100% of your home value), pressure you into making an immediate decision, refuse to give you copies of signed documents, ask you to sign paperwork before it has been filled out, or encourage you to lie on your application.[6] These mistakes are costly and can result in you losing your home to foreclosure or not being able to afford your monthly payments.
  3. Apply for the loan. Once you have chosen a lender, it is time to apply for your loan. Preview your paperwork before you sign. Ask for a "Good Faith Estimate." They are required to send you this estimate within 3 days of you applying for the loan. Also, ask them for blank copies of the forms before you sign them. Take the time to read over them. Ask questions if there is anything that you do not understand.[7]
    • You can apply for your loan online and in person. Do what you are most comfortable with. However, applying for the loan in person will give you an opportunity to talk with someone if you have questions.
    • If your lender has promised you anything, ask them to put it in writing.
    • Fill out all of the necessary application forms. Many lenders will accept online applications, but some financial institutions will require you to be present why you apply for your loan.
  4. Close on your loan. Read the loan documents carefully before you sign them. Make sure you understand the terms of repayment and the interest rate. All of the terms and conditions (e.g. interest rate, length of the loan, etc.) of the loan should match the original agreement. If there any changes to what you discussed with your lender, ask questions. By law, you can review the final loan statement one day prior to closing.[7]
    • Get a copy of all signed documents before you leave the lender.
    • Never feel pressure to sign your documents. If anything is not right, do not sign them.

Tips

  • Pay attention to the state of the housing market. Having a home equity loan can be dangerous if your house begins to lose value. Your equity will decrease, and you could end up owing more than your home is worth.
  • Talk to a financial consultant or a tax planner about the potential tax benefits of paying interest on a home equity loan.

Related Articles

  • Consolidate Loans
  • Calculate Mortgage Insurance (PMI)
  • Acquire Low Interest Refinancing Mortgage Rates
  • Calculate Amortization Quarterly
  • Avoid Foreclosure by Knowing Your Mortgage Type
  • Calculate Mortgage Interest
  • Avoid Mistakes when Buying a Home

Sources and Citations

  1. ↑ 1.0 1.1 http://www.investopedia.com/terms/h/homeequityloan.asp
  2. ↑ 2.0 2.1 2.2 2.3 http://guides.wsj.com/personal-finance/buying-a-home/the-basics-of-home-equity-loans-and-lines-of-credit/
  3. ↑ 3.0 3.1 http://files.consumerfinance.gov/f/201204_CFPB_HELOC-brochure.pdf
  4. ↑ http://www.investopedia.com/articles/pf/05/041305.asp
  5. ↑ http://www.learnvest.com/knowledge-center/home-equity-loans-are-back/
  6. ↑ http://www.in.gov/dfi/2492.htm
  7. ↑ 7.0 7.1 https://www.fdic.gov/consumers/assistance/protection/mortgages/predatory/index.html
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