When does a home equity loan make sense?

CNN
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While the pandemic created unique challenges in nearly every sector of the economy, the US housing market surprised everyone by holding strong, and that pattern has continued into 2021.

Recent data from the National Association of Realtors shows that, from June 2020 to June 2021, the median price for single-family existing homes saw a near-record year-over-year increase of 22.9%. And interest rates for many financial products continue teetering near record lows.

This has left many consumers wondering if now’s the best time to access the equity that’s built up in their homes over the last few years. If you have a lot of cash trapped in your home, it’s smart to learn more about home equity products, how they work and how you can use them to reach specific financial goals. Let’s take a deeper look at home equity loans and why now may be a great time to consider one.

Similar to a mortgage, a home equity loan is a debt that’s secured by the equity in your house or apartment. If you’re not familiar with the term “equity,” it’s the amount that your home is currently worth, minus any debt you have on it in the form of a mortgage or other loans. Usually a home equity loan serves as an additional debt on top of an already existing mortgage.

When you take out a home equity loan, you borrow a fixed amount of cash and agree to pay it back over a fixed length of time. Home equity loans also come with fixed interest rates and fixed monthly payments, so they’re easy to budget and plan for.

Some people prefer to apply for a home equity line of credit (also called a HELOC) instead of a home equity loan. The basics are the same, but with a home equity loan, you receive all the cash from the loan in one lump sum, while with a home equity line of credit, you don’t get cash up front, but you have a line of credit that’s available to draw on when you need it.

There can also be tax advantages with a home equity loan or line of credit. While the rules have tightened in recent years, interest on a home equity loan or line of credit can be deductible if you use the funds specifically for renovations or additions to your home. That can give home equity loans a major advantage over many other types of debt.

In either case, since a home equity loan or line of credit is secured by the equity in your home, if you’re unable to pay it back for any reason, a lender can foreclose on your home to collect the debt. So it’s important to have a plan for paying off your home equity loan on time, and only take on as much debt as you can afford.

Click here to compare offers from home equity lenders at LendingTree, an online loan marketplace.

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You’ll need a good credit score and adequate income to qualify for a home equity loan.

The first step in applying for a home equity loan is having enough equity in your home to qualify. Generally speaking, most home equity lenders will only let you borrow up to 85% of your home’s value in total between your mortgage and a home equity loan.

For example, if your home is currently worth $400,000, you could owe a total of $340,000 on your mortgage and a home equity loan. So if you already owe $300,000 on your home, you could qualify to cash out another $40,000 with a home equity loan.

Depending on your situation, it’s likely you’ll need to have your property appraised to determine how much it’s worth in today’s market. Your home equity lender will usually facilitate this process for you, although an appraisal fee is typically required.

Your credit score is another factor that comes into play if you want to qualify for a home equity loan. While each lender has their own qualification criteria, you’ll have the best chance at approval if your FICO score is at least “good” — meaning 670 or higher. And you’re more likely to get the best rates and terms on a home equity loan if your FICO score is “very good,” which is generally 740 and higher.

Related: How to instantly improve your credit scores for free with Experian Boost.

To qualify for a home equity loan, you’ll also need to be able to prove your ability to repay. You can typically do this by presenting pay stubs or proof of any other ongoing source of income you have, such as investments or self-employment income. If your home is owned by both you and your spouse together, you should be able to use your joint income to qualify for a home equity loan.

Finally, a home equity lender will consider your debt-to-income ratio, which is how much debt you already have in relation to the income you bring in. Generally speaking, lenders prefer consumers with debt-to-income ratios of 43% or below.

See if you qualify for a home equity loan at LendingTree.

If you plan to cash out the equity in your home so you can try your luck at the local casino, you should probably avoid getting a home equity loan — or any loan for that matter. However, there are many ways to use home equity loans for a practical purpose, and even to save money over the long run.

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There are several scenarios in which getting a home equity loan can make sense.

Here are some instances where home equity loans can make sense:

Generally speaking, since interest rates on home equity loans are more competitive than those on credit cards and other financial products, it can make sense to use a home equity loan if you’re eligible for a low interest rate based on your credit score.

Related: How can you check your credit score?

Just remember that if you’re consolidating debt from a credit card or personal loan into a home equity loan, you’re exchanging unsecured debt for secured debt. While you’ll likely lower your interest in the process, if you don’t pay back the money, your home is at risk. Leaving your debt in an unsecured vehicle like a credit card eliminates that risk, though you can still suffer negative consequences if you don’t pay your debt, no matter what form it’s in.

Save money with home equity loan offers at LendingTree.

Like other financial products, home equity loans often have fees that may not be obvious unless you’re looking for them. According to the Federal Trade Commission (FTC), you could be asked to pay an application or loan processing fee, as well as an origination fee of up to 5% of your loan amount.

You will also likely need to pay for an appraisal to prove your home has enough value to support the loan, and you may also face document preparation fees, recording fees or broker fees as well. So it’s important to ask about fees up front and look for lenders who offer home equity loans with very limited “extra” fees and closing costs.

If you’re considering a home equity loan, make sure to shop around and compare lenders, their rates and the fees they charge. One way to do that is through an online marketplace such as LendingTree, which offers the convenience of only having to submit your details once, and then getting offers from multiple lenders that you can compare and consider.

Check your rates now at LendingTree and see offers from multiple lenders.

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You’ll want to look at all your options before choosing to get a home equity loan.

A home equity loan can be attractive if you’re looking for ways to borrow money, but there are also other ways to get cash if you need it. So before you pull the trigger on a home equity loan, you should also consider the following:

Personal loans

A personal loan lets you borrow a fixed amount of money with a fixed monthly payment and a fixed repayment term. However, personal loans are not backed with collateral, so you don’t have to have a specific amount of home equity or any other collateral to use one.

If you don’t own a home, or if you don’t have enough equity in your house or apartment to be able to take advantage of a home equity loan, a personal loan could be a better option.

Credit cards

If you need to access a line of credit to make some purchases and you don’t expect to take more than a year to pay off your debt, you should consider a credit card with an introductory interest rate offer. Many of the top options let you earn rewards on your spending while enjoying zero interest on purchases or zero interest on balance transfers for 15 months or even longer.

Related: How to get the best credit card when you have an excellent credit score.

A credit card can be a valuable tool if you need to borrow a…