How Home Equity Loans Work
Even the most careful and money-conscious homeowner can have sudden expenses arise that require a financial boost. Whether you’ve had a surprise medical bill or you’re in need of costly repairs and renovations, the solution may already exist in your home’s equity.
As you pay down your mortgage, make improvements, or your property value increases, you build equity in your home. Equity is the difference between what you owe on your home and how much your home is worth, and lenders offer several different home equity options that can help you get the cash you need. These loans can be used for all sorts of things, including home renovations, debt consolidation, and emergencies.
What Is a Home Equity Loan?
Home equity loans allow homeowners to utilize the value they’ve built up in their home to get a lump sum of cash. In other words, they take advantage of the difference between the amount you owe on your home and the value you’ve accrued. Since home equity loans often have lower interest rates than personal loans and credit cards, they can be a useful tool for homeowners.
Sometimes called second mortgages, it’s important to understand the type of home equity loan that works best for your situation. By the time you’ve read this guide, you’ll be ready to compare home equity lenders and begin the process.
Pros and Cons of Home Equity Loans
What Types of Home Equity Options Are There?
Once you built up equity, there are several home equity options you can use to make the most of it. You’ve probably heard of three of the most common options: fixed-rate home equity loans, home equity lines of credit, and cash-out refinance loans. But more recently, a fourth option has emerged: home equity investments. Although each is similar, there are important differences between them that should be noted.
Fixed-rate home equity loan
With an interest rate that doesn’t change throughout the course of your loan, a fixed-rate home equity loan can make budgeting easy. Whether you’ve opted to repay the loan in five years or in 30 years, your payment will always be the same. Secured by your home’s value, your interest rate will never budge.
Home equity line of credit (HELOC)
Home equity lines of credit (HELOCs) also use your home as collateral, but they’re different than standard home equity loans. When you take out a HELOC, you’re granted a revolving line of credit. So, up to a certain amount, you can draw from the line of credit again and again. In this way, HELOCs are similar to credit cards. Unlike home equity loans, many HELOCs have variable interest rates.
Cash-out refinance loan
A cash-out refinance loan pays off your existing home loan. However, this type of loan requires that you take out a larger mortgage. When you do, you pocket the difference between the amount of the loan and the amount of equity you have in your home. If you’re also interested in refinancing to a lower interest rate, then this option is a way to refinance and access a lump sum of cash at the same time.
Home equity investment
Want to tap into your home’s equity without taking out a loan? A home equity investment is an alternative worth considering. In exchange for a portion of the equity you have in your home, a home equity investment gives you cash for a share of your home’s future value. There’s no interest and no monthly payments because it isn’t a loan. By the end of the agreement, you pay back the investment.
Home Equity Loan vs. Home Equity Line of Credit
When you take out a home equity loan, you’re given a lump sum of cash you can pay back over a set number of years. With a home equity line of credit (HELOC), you can access your line of credit repeatedly for a set amount of time.
Home Equity Loan vs. Cash-Out Refinance Loan
Both home equity loans and cash-out refinance loans allow you to receive a one-time cash payment. However, cash-out refinance loans replace your current mortgage — sometimes increasing your payments. On the other hand, home equity loans create a second mortgage payment.
Home Equity Loan vs. Home Equity Investment
Home equity investments allow you to use your home’s equity without monthly payments or interest fees. That’s because home equity investments, also known as home equity alternatives, aren’t loans. They’re investments that need to be paid back at the end of the agreement. Some homeowners sell their homes, while others buy out the investment through other means like savings.
What Can You Use Home Equity Loans For?
There are many uses for home equity loans, but common reasons people choose to borrow against the equity in their homes include:
- Home renovations
- Debt consolidation
- Education expenses
- Emergency expenses
Home equity loans allow you to use your funds in any way you see fit. Whether you need a new roof or extra college tuition, home equity loans come without spending restrictions.
Compare Our Featured Picks
Quicken Loans is a direct lender with great options and flexibility for people looking to refinance or purchase a home. But what many people may not be aware of is that Quicken Loans also has home equity loans. As with their approach to home purchase and mortgage refinance, Quicken Loans works to make their home equity options accessible and easy to understand.
The company clearly prides themselves on being rated highest in customer satisfaction by J.D. Power for 11 years running. The site has a helpful library of educational articles and online calculators you can use for free. With a fast online application, Quicken Loans helps you take advantage of your hard-earned equity sooner rather than later. Read the full review.
AmeriSave is a digital lender that put themselves on the map as a non-bank resource for home purchase loans and home refinance. While they don’t have home equity loans in the traditional sense, the company does have cash-out refinancing. This option doesn’t work the same way as a home equity loan, but it is a way to tap into your home equity for cash while also refinancing your mortgage.
If you’re looking for a standard home equity loan (or you reside in the state of New York), then AmeriSave isn’t the best option for you. But if you live in the other 49 states and you’re open to other strategies for unlocking your home equity, then AmeriSave could be a great fit. The company makes it easy to get a pre-qualified rate quote in just three minutes. Read the full review.
You may be most familiar with Discover as a credit card company. However, it’s also worth familiarizing yourself with the variety of loan services they offer, including home equity loans. Their loan amounts range from $35,000-$300,000, making it easy to tap into your home equity for moderate to large sums.
There are also some significant benefits to working with a large company like Discover, such as lower fixed rates and payments than you might see from a more specialized entity. Likewise, their size allows them to operate in all 50 states. If you have questions during the process, you can contact your dedicated personal banker any time. Read the full review.
Frequently Asked Questions
What are the requirements for a home equity loan?
In order to qualify for a home equity loan, experts recommend having at least 20% equity in your home. Additionally, you’ll likely need a debt-to-income ratio of less than 40% and a credit score that falls in the good to excellent range (650+).
Is there an appraisal with a home equity loan?
If you’re applying for a home equity loan, then your home will need to undergo an appraisal. Lenders send certified appraisers to assess condition, square footage, number of bedrooms, and bonus spaces.
Can you get a home equity loan on a home that is paid off?
Yes. If your home is paid off, then it actually might be easier for you to get a home equity loan. So, as long as you meet all the lender’s criteria (debt-to-income ratio, loan-to-value ratio, and good credit history), a home equity loan can be processed.
Is a home equity loan like a personal loan?
Home equity loans and personal loans can be spent to cover any need, but they are very different. While home equity loans require that you use your home as collateral, personal loans often don’t require collateral. As secured loans, home equity loans often have lower interest rates, though.
How do home equity loans and reverse mortgages compare?
When you take out a home equity loan, the lender pays a lump sum that the homeowner must pay back over a period of time. With reverse mortgages, the homeowner receives monthly payments from a lender. When the homeowner moves, passes, or sells, the lender recoups their funds.
Too Long, Didn’t Read?
There are several options for taking advantage of your home equity. Four popular options — home equity loans, cash-out refinance loans, home equity lines of credit, and home equity investments — give homeowners the opportunity to turn their equity into cash for home improvements, debt consolidation, etc. If you’re interested in taking the next step, then you’ll want to compare top home equity lenders and view rates. Starting the process is as simple as that.