- To fund a college education
- To remodel a kitchen or other home improvement project
- To buy a car
- To consolidate debts so you can pay off those high interest credit cards
- To pay for medical bills
So, if you need funds for one of these or another purpose, the equity in your home could hold a ready source of funds.
Equity and Collateral
Simply stated, equity is the difference between what your home is worth and what you owe on it. So, if your home is appraised at $150,000 and you owe $100,000, you have $50,000 worth of equity in your home.
Equity in your home is considered collateral. That means if you default on the loan by not making payments, the lender could take possession of your home. Home equity is a loan source with many advantages but you have to make sure and stay current with the repayment schedule.
Just because you have $50,000 equity in your home doesn’t mean you’ll be able to borrow that entire amount. The way the process works is like this:
- Your home is worth $150,000 and you owe $100,000 on it. There is $50,000 equity in the home. The lending institution will allow you to borrow up to a certain percentage of the home’s value. If that is 80%, then you’ll be able to borrow up to $120,000 on a home worth $150,000. If you still owe $100,000, then you’ll be able to borrow $20,000 of the equity in your home.
Advantages of a Home Equity Loan
There are many advantages to obtaining a home equity loan as a vehicle to pay for the items mentioned above. For example, you’ll be able to:
- Obtain flexible loan terms. Repayment terms can be for as little as five and as long as thirty years in length
- Take advantage of a fixed interest rate. This way the repayment amount will be the same throughout the life of the loan. You’ll be able to budget your expenses knowing the payment will never change.
- Deduct the interest on your taxes. You’ll have to check with a tax expert to be sure, but in most cases you can deduct the home equity loan interest when you prepare your personal tax return. It works the same way as the interest you deduct on your original mortgage.
Obtaining a Home Equity Loan
Now that you’ve thought it through and know a little bit about home equity loans, the next question is, what will it take to get one? Well, the process is very similar to buying a home. Here’s what the lender will need:
Credit Report: One of first pieces of information that will be reviewed by the loan company is your credit report. The shape of your credit will not only be a factor on whether or not you’ll even be considered for the loan, it will determine what interest rate you’ll be eligible for. The higher the credit score the better.
Proof of Income: Lenders want to know about your ability to repay. You’ll have to supply proof of income and employment for at least two years by submitting pay stubs, income tax records or both. The more stable the income history, the better.
A Home Appraisal: The lender will require a current appraisal, maybe more than one, on your home. This can be very important. For example, if you think your home is worth $150,000 but the appraisal comes in at $120,000 that will change the entire loan picture.
Using the example above, the appraisal would lower the home’s value. 80% of $120,000 is $96,000. If you owe $100,000 on the home, you wouldn’t able to obtain a home equity loan because you no longer have equity in the home.
Those are the big three pieces of information you’ll need to apply for a home equity loan. However, it may not end there. You’ll likely be asked other questions about past or current debts or have to provide other documentation (like proof of insurance or a letter from your employer) during the application process.
Again, if you receive a loan, you will close on it like you did for the loan when you bought the home. There may also be fees involved. These could include the appraisal fee, title fees, closing fees and other fees applicable to your state, county or lending institution.