Here’s how it works: You’ll choose a lender and apply for a loan just like you would for a traditional mortgage. You will also need to have your home appraised to determine its current value, as this helps the lender assess your equity and the total amount you can borrow. Finally, you will close your loan and receive a lump sum payment a few days later.
You can use the proceeds of your home loan as you see fit. Many homeowners use them to pay for renovations or repairs, although they can also be used for tuition, medical bills, or even paying off higher-interest debt, among other expenses.
Requirements for Home Equity Loans
The exact requirements for a home equity loan vary by lender, but at the very least, you can expect to need 10% to 20% equity in your home.
To calculate how much equity you have, you first need the market value of your home. Once you have applied for the loan, your lender will order an appraisal to get an official number, but at this point you can ask a local realtor or check with your appraisal district. They should have an estimated market value on file for your home.
Next, subtract the remaining balance on your current mortgage. For example, if your home is valued at $400,000 and your mortgage balance is $300,000, then you have $100,000 of equity or 25% (100,000 / 400,000 = 0.25 ).
In addition to this, you will also need:
- At least a credit score of 680although some lenders may require a higher score
- A debt to income ratio (DTI) or 45% or lessmeaning that your total debt, including your new home equity payment, is less than 45% of your monthly income
- A loan-to-value ratio of 80% to 90%, including your current mortgage balance and the amount of home equity requested
Keep in mind that while some lenders may still consider some applicants with lower credit scores, those scores may not qualify you for maximum funding. You can also pay a higher interest rate if your score is low, as this compensates the lender for your additional risk.
How to Get a Home Equity Loan
If you own a home and need cash, a home equity loan may be an option to explore. Follow the steps below to get started.
1. Determine what you need and how much you can borrow
Home equity loans offer an initial lump sum payment on which you will pay interest for the duration of your loan. To minimize these interest charges, it is important to borrow only what you need.
As Bryan Toft, chief revenue officer at Sunrise Banks says, “Do your homework first. Find out how much of a loan you need, what your interest rate might be, and make sure you only take out a loan you can afford.
Try to be as accurate as possible when estimating your costs. If necessary, you may want to get quotes from contractors (if you’re doing renovations, for example) or bring in other experts to help refine your estimate. The more specific you are, the more you can minimize your long-term interest.
You will also need to determine how much you box borrow from your house. To do this, you will again need your existing mortgage balance and the current market value of your home (you can ask a real estate agent or check with your local appraisal district for this).
Most lenders will allow you to borrow up to 80% to 90% of the value of your home, minus your current loan balance. So if your property is worth $600,000 and your mortgage balance is $350,000, you could potentially access $190,000 (600,000 x 0.90 – 350,000 = 190,000).
“To qualify for a home equity loan, you must have accumulated equity in your property,” says Jon Giles, head of consumer direct lending for TD Bank. “So it may not be the best option for a new homeowner who hasn’t invested a substantial amount of money during the buying process and hasn’t lived in the house for long.”
Remember that you will not necessarily be entitled to the maximum amount offered by a lender. Your credit score, DTI ratio, and other financial factors will also influence how much you can borrow.
2. Research lenders
Many lenders and banks offer home equity loans, but their requirements, conditions, fees, and limitations may vary from loan to loan. For this reason, it’s important to consider at least a few options before deciding which company to proceed with.
When researching lenders, you will want to consider:
- All eligibility requirementsincluding maximum DTI ratios, minimum credit scores and the equity you need in your home.
- Any minimum or maximum loan amount the lender may have
- Their rates and fees, including application fees, set-up fees and subscription fees
The Federal Trade Commission (FTC) recommends starting your search with your current lender or bank, as they may offer reduced rates or fees. You should also consider a few other financial institutions, making sure you get details of their fees, payment terms and any prepayment penalties.
You can keep track of the lenders you plan to use home equity worksheet. Don’t be afraid to show lenders what others have offered you. They may be open to negotiating terms and fees to earn your business.
3. Apply for the loan
For home equity loans, “the application process is the same as for a first mortgage,” according to Bill Banfield, executive vice president of capital markets at Rocket Mortgage.
This means, just like your first mortgage, you will need to complete your lender’s application, accept a credit check, and submit various forms of financial documentation. These include:
- Bank statements
- Statements for any assets or retirement accounts you have
- tax returns
There may be other requirements, particularly if you are self-employed. This may include a profit and loss (P&L) statement, balance sheet and business bank statements. Be sure to stay in touch with your loan officer and respond promptly to any document requests, as any delays could slow down your request.
4. Have your home appraised
The value of your home plays a key role in how much equity you have and how much you can borrow with a home equity loan. As such, you can expect your lender to order an appraisal of your property after submitting your application.
“There’s a common misconception that a person’s home equity is only the amount of their down payment when they bought the house,” says Shmuel Shayowitz, president of mortgage lender Approved Funding. “It certainly isn’t, and all lenders and banks will use your home’s current appraised value.”
There are several types of appraisals, including full appraisals, in which a professional appraiser will physically assess your home inside and out; drive-through appraisals, which combine a look at your home’s curb with property records and sales data; and office appraisals, which only use records and sales data to assess the value of your home. The type of appraisal your home will need depends on the lender.
5. Complete the loan and receive your money
Finally, you will receive a closing appointment, during which you will sign your loan documents, pay the fees and finalize your home equity loan.
Overall, the whole process can take two weeks to two months, according to Cameron Findlay, chief economist at AmeriSave Mortgage Corp.
“Factors that affect timing include the quality of preparation of all necessary documents, the efficiency of the underwriting process, and whether or not additional information is required,” says Findlay. “If your loan requires an in-person appraisal, the appraiser’s availability may also come into play.”
Once you have taken out your loan, there is a mandatory three-day waiting period in case you want to cancel. After that, your lender will issue your full lump sum payment.
The take-out sale
Getting a home equity loan works much like applying for your first mortgage. You will research lenders, apply for a loan, provide documents and have your home appraised. Once all is said and done, you will receive your funds, which you can use for any purpose, within days.