Home Equity Loans

A home equity loan allows homeowners to borrow money using the equity in their homes as collateral. It is essentially a second mortgage tied to your home or property. Home equity loans include fixed-rate, no-appraisal and appraisal loans, and home equity lines of credit offered at variable rates.

Each of these has its pros and cons, and it helps to understand what they are before choosing the right option for you. Here is a guide to help you understand more about what you can expect through the home equity loan process.

Definition of a Home Equity Loan

Home equity financing is available to homeowners who have built up enough equity in their home. This equity is usually based on the difference between the home’s value and what’s left on the mortgage. Essentially, these are loans you can take against the equity in your home. 

Most financial institutions generally allow you to borrow up to a certain percentage (commonly around 80%) of your home’s appraised value, after subtracting any existing mortgage balance.

Depending on the current market value, your home’s equity determines the loan amount and terms you can get. The loans are offered at lower interest rates than unsecured loans because they’re backed by your home, which makes them less risky for lenders. But keep in mind, they typically have higher rates than first mortgages.

Purpose of Home Equity Financing 

A home equity loan can be used for numerous purposes, including:

Paying Down Other Debts 

One of the most common reasons people choose home equity loans is for debt consolidation. The lump sum loan can help pay off debts with high interest rates, like personal loans and credit cards.

Instead of having multiple loans, debt consolidation allows you to have one loan with a lower interest rate. You only have to worry about making one monthly payment rather than dealing with many lenders and several loans, simplifying your budget and reducing your overall rates.

Home Repairs and Upgrades

You can use your home equity to tackle various home repairs and upgrades. Some great updates to consider include refreshing your kitchen and bathroom, adding energy-efficient heating and cooling systems, installing water-saving fixtures, and giving your home a fresh coat of paint inside and out. These improvements can really boost your property’s value.

If you’re looking for a way to fund these updates, a RenoFi HELOC could be a good fit. It lets you tap into your home’s equity to help cover the costs. 

For example, imagine your home is currently valued at $500,000, and your outstanding mortgage balance is $400,000. You are planning a renovation and expect that the after renovation value of your home would be approximately $640,000. Your current loan-to-value ratio (LTV) is at 80%, which means that you effectively can’t borrow anything to fund your renovation. A RenoFi loan, however, would allow you to go as high as 150% LTV or 90% LTV using the after renovation value.

So in this example, while using a standard home equity loan results in your borrowing power being $0, a RenoFi loan allows you to borrow up to $176,000 thanks to the after renovation value of your home!

If you are considering a home renovation, RenoFi is by far the smartest way to finance your project. Learn more and explore your borrowing options here.

Other Expenses or Uses

It is also worth noting that you can use a home equity loan to build an emergency fund, pay for college, or even help you become a business owner. 

You will find that most lenders won’t restrict you when it comes to how you can use your home equity funds. However, you do want to avoid making risky investments and to understand the full cost of your loan. Make sure you can afford the payments since you are borrowing against your home. 

Features of Home Equity Loans

Equity loans differ from other consumer loan options. Generally, they have a higher interest rate than a first mortgage but are still lower than the rates typically found with credit cards or other unsecured loans.

Another feature of a home equity loan is its fixed rate, which implies the interest rate on the loan remains the same until the end. For instance, if the interest rate is 12% when you access it, you will pay 12% even if there is an increase or decrease in rates due to inflation and other market changes. 

Additionally, these loans usually have a higher annual percentage rate (APR) than your primary mortgage. The APR takes into account the interest rate plus all the extra fees associated with the loan. There are several fees that come with these loans, including appraisal, origination, title, closing, and more. All those costs get included in the APR, along with the fixed interest rate you lock in. So the APR gives you a better idea of the total price tag for the loan.

How an Equity Loan Works

A home equity loan is a second mortgage for homeowners, and the application process is simple. Banks or other lending institutions use your home as security or collateral for the loan to protect themselves if you default. They check the loan-to-value ratio of your appraised home using the current market value and the mortgage balance to determine the amount of the loan you can apply for. Most lenders allow you to apply for a loan between 80 and 90 percent of the combined loan-to-value ratio.

When applying for home equity, the lending organization uses your home’s equity and mortgage balance to check eligibility for the loan before allowing you to apply. Before they approve the loan, lenders check your credit score and payment history to know your creditworthiness. 

Once you get the home equity loan, the lender will explain the monthly installment repayments. Each payment is usually made up of a principal amount and a fixed interest rate that will remain the same until pay off the loan. For instance, if the monthly installment is $2,000, you will pay that amount for the entire loan term.

Your Guide on How to Apply for a Home Equity Loan

1. Determine If You Are Eligible for the Loan

Knowing if you qualify for the home equity loan should be the first step. Like consumer loans, homeowners should meet all the requirements the bank or mortgage institution sets to qualify. 

Here are some requirements that make you eligible for the equity loan:

Owning a property or home through a mortgage

A crucial requirement for a home equity loan is having an active mortgage you are still paying on. The lending institution will check your home’s current market value to help them calculate your loan limit and determine whether you qualify for the funds.

Appraisal of the home

After qualifying, the next step is a home appraisal. This is a valuable step in the US residential mortgage underwriting process. The appraisal company will send an appraiser to check your home’s condition and figure out its current market value. This helps them assess the risk of default. The appraisal value and the mortgage balance help determine the loan-to-value ratio and the amount of money you are eligible to borrow. If you want to qualify for a no-appraisal home equity loan, the lenders will skip the expensive appraisal process.

Evaluation of your financial health

Before lenders approve your loan, they will check if you have verifiable income. Then, they evaluate your debt-to-income ratio to understand your financial stability and determine your ability to repay.

The lender will compare all your earnings and debts. Loan experts consider several things, including your monthly mortgage payment, insurance, real estate tax payments, car payments, credit card payments, personal loans, and child support payments as debts. They also compare monthly expenses with earnings, such as salary, pension, social security, bonuses, or wages, to get the debt-to-income ratio. If the debt-to-income ratio is lower, the lender considers you eligible for a loan, and vice versa.

2. Learn More About Your Home Equity Loan Options 

Next, you should know all the available types of home equity loans so you can choose the one that best suits your financial needs and plans. When weighing your home equity loan options, evaluate the following options.

Home Equity Line of Credit (HELOC)

A HELOC is an equity loan that helps you convert your home equity into cash. HELOCs are different from home equity loans in a few ways. First, traditional HELOCs are offered at variable or adjustable rates, meaning they can increase or decrease, depending on inflation or market changes. Secondly, they usually provide a line of credit instead of a lump sum upfront. With a traditional HELOC, you can borrow what you need over time. 
However, with a RenoFi HELOC, you can actually access the entire approved amount right at closing, which is great for funding your renovation projects. In addition, it’s possible to get a fixed-rate option from some of our lending partners rather than only a variable-rate HELOC.

With HELOCs, there’s generally a draw period where you can borrow what you need, when you need it, and you only have to pay back the amount you borrowed, plus interest. One of the advantages of HELOCs is that some may have low upfront fees. However, many lenders charge upfront fees such as application, appraisal, closing, or origination fees. 

Instead, you have a set period where you can borrow what you need, when you need it, and you only have to pay back the amount you borrowed, plus interest. One advantage of these loans is that they have no upfront fees. 

Fixed-Rate Home Equity 

Home equity loans differ from HELOCs in that they are offered in a lump sum at a fixed interest rate. You will typically need an appraisal (99.9% of the time) for a fixed-rate home equity loan, and it is uncommon for lenders to waive this requirement. 

3. Learn the Pros and Cons of Home Equity Loans

Learning and understanding the benefits and limitations of home equity loans helps borrowers weigh their options and make wiser financial decisions.

Benefits of Home Equity Loans

• Lower Interest Rates on Debt: Home equity loans compared to other loan types, such as personal loans or credit cards, are subject to lower rates because your home acts as collateral or security.
• One-time Funds or Lump Sum Loans: Equity loans are best for those who need one-time funding to address their financial issues at once. The borrower gets between 70 and 90 percent of their equity minus their mortgage balance. For instance, if their equity value is $500,000 and their first mortgage balance is $150,000, the homeowner can get $400,000 - $150,000, a $250,000 loan amount, in a lump sum. 
• Possibility of Tax Deductions on Interest Paid: In some cases, you can deduct interest paid on these loans on your yearly taxes, if you use the funds for investments in the property and home improvement. 

Disadvantages of Home Equity Loans

• More Debt Burden: A loan increases your debt due to the extended loan term and additional rates
• High Risk of Foreclosure: If you default, you are at a higher risk of losing your property through foreclosure. Plus, if you fail to make your payments, it can hurt your credit score.  
• Higher Interest Rate: In some cases, home equity loans may have a higher interest rate compared to HELOCs, which can result in paying more interest over the life of the loan. However, interest rates can vary based on factors such as the lender, your creditworthiness, and market conditions. 

Benefits of RenoFi Loans

While a traditional home equity loan may sound like a viable option to fund a home renovation project, it often doesn’t work because the available equity isn’t enough to tackle your entire wishlist. One way to solve for that is to take into account the After Renovation Value of your home and use that to increase the available equity - this is what RenoFi loans do.

For instance, imagine your home is currently valued at $500,000, and you owe $400,000 on your mortgage. You plan to renovate and estimate that the value of your home will rise to $640,000 after the renovation. With your current loan-to-value (LTV) ratio at 80%, you cannot borrow any funds for the renovation using a traditional Home Equity Loan. 

However, a RenoFi loan allows you to increase your LTV up to 150% or 90% of the after-renovation value. This means that while a standard home equity loan gives you no borrowing capacity, a RenoFi loan enables you to borrow up to $176,000 based on your home’s future value.

If you’re considering a home renovation and need a HELOC that gives you greater borrowing power, exploring RenoFi’s options might be the perfect solution for you.

4. Weigh your Options and Apply

Now that you know more about the home equity loan process, it’s time to weigh your options. Assess the loan terms and conditions and the period it will take you to finish paying it off before you apply. 

Conclusion

Home equity loans can be a great choice for homeowners who have built up a good amount of equity in their homes. Financial experts can provide a comprehensive guide on equity loans to ensure you understand everything before making your final decision. Learn your eligibility status, loan interest rates, loan terms, long-term implications, and the pros and cons of the home equity installment loan. 

At RenoFi, you can find guides to help you understand the home renovation financing process, including information on second mortgages like home equity loans and HELOCs.

 If you’re planning to do a home renovation project, RenoFi loans are the smartest way to finance your project. Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans are based on the After Renovation Value of your home. This allows you to borrow on average 11x more, get a low monthly payment and keep your low rate on your first mortgage.