Own your own home? In need of cash to pay for a renovation, medical expenses, college tuition, or some other major expense? You may be able to use a home equity loan or home equity line of credit (HELOC) to tap into your equity to access funds.
Because the borrower’s home is used as collateral, a home equity loan usually has lower rates and more flexible qualifying requirements than other alternatives such as personal loans. The repayment terms often last for up to 15-30 years, giving you plenty of time to pay off the debt.
Here’s everything you need to know about home equity loans and HELOCs, including our list of the top 3 home equity lenders in 2021.
A home equity loan is a fixed-rate loan in which the borrower uses their home equity as collateral. The loan creates a lien against the borrower’s home and reduces the borrower’s home equity. As the borrower makes payments, their home equity increases again. A home equity loan term can range from 5-30 years although most lenders allow 5-15 years.
A home equity line of credit, or HELOC, is an alternative home equity product. Like a home equity loan, a HELOC uses the borrower’s home equity as collateral. But in contrast to a home equity loan, a HELOC is an open-end revolving line of credit with an adjustable interest rate. With a HELOC, the borrower may draw funds at any time, up to the approved credit limit. The borrower only pays principal and interest on the funds drawn, in addition to certain closing fees at the start of the loan.
The basic requirement of a home equity loan is that you own your home. Most lenders permit a combined loan-to-value (CLTV) ratio of up to 90%, meaning your home equity cannot go below 10% of your home’s current appraised value. However, some credit unions allow 100% CLTV. Generally, home equity loans can only be taken on owner-occupied properties, although in some cases it may be possible to use a rental or investment property as collateral.
Applying for a home equity loan or HELOC is quite similar to applying for a regular mortgage. It typically involves:
Closing costs for home equity loans and home equity loans can reach up to 2-5% of the loan amount. Many home equity lenders are open to negotiating the closing costs, so always shop around before making a decision.
Home equity loans offer many benefits compared to alternative products. The average interest rate on a home equity loan in 2021 is 3-5%, substantially lower than the average personal loan rate of 10-20%. Although cash-out refinances are available at slightly lower rates, home equity loans usually have lower closing costs – making them the best option for tapping into your home equity for modest loan amounts. Home equity loans come in many shapes and sizes, so always compare a few lenders before making a final decision.