A large advantage of being a homeowner is being able to use your home equity to finance other projects at a relatively low-interest rate.
A home equity loan is a useful type of loan available to homeowners who have sufficient equity in their property. A home equity loan allows a homeowner to take out a loan against the equity they may have on their house, which allows the homeowner to receive a much lower interest rate than an uncollateralized loan. This loan can be used for different purposes and are usually as free to use as personal loans. In this sense, a home equity loan is a personal loan that uses home equity as collateral.
Eligibility for Home Equity Loans
Not everyone can apply for a home equity loan because this loan is only accessible to homeowners who have equity in their homes. This means that people who do not own any type of property or people whose mortgage principal outstanding is larger than the value of their property, would not be able to get a home equity loan. In addition to that, the lenders may set certain requirements to make sure that the borrower can cover monthly payments given their earnings, expenses, and other liabilities. Usually, lenders require a loan-to-value (LTV) ratio of no more than 80% although some lenders may allow the LTV of 85%. Apart from the LTV, the lenders also require a minimum credit score of 620 and proof of income for some borrowers.
No law specifically regulates home equity loan requirements, so the requirements may vary from lender to lender. Since the lenders may provide slightly different products, it may be wise to visit multiple lenders and pick the most appropriate home equity loan. This strategy may allow a borrower to get a home equity loan faster and save money through a lower interest rate.
It is important to note that there are alternatives to home equity loans that may be more useful for some borrowers. For example, the Home Equity Line of Credit (HELOC) provides a line of credit rather than a loan. This may be more useful for borrowers who are not planning to spend the money frequently. Even though HELOC usually has a higher interest rate than home equity loans, it provides flexibility. HELOC monthly payment calculation is largely affected by the outstanding principal. Since HELOC allows not to use all principal available at once, some HELOC users can save money compared to using a home equity loan.
Getting Documents for the Loan
A home equity loan is a collateralized loan, so it requires a lot of documents and potentially even some inspections before it can be originated. These documents are important because they will be used to calculate home equity loan payments and the maximum principal offered. The following list provides an overview of the documents required for a home equity loan.
- Social Security Number
- Employment History
- Proof of Income for the Past 2 Years
- Two Most Recent W-2 Statements
- Proof of Ownership of the Home
- Home Insurance Declarations
- Recent Mortgage Statement
- Appraisal of the Collateral
- Disclosure of Liens on the Collateral
Some lenders may require additional documentation depending on the situation, but most of the lenders will require the documents listed above. It is best to prepare the documents before looking for a lender because prepared documents allow a borrower to have more negotiating power and get more precise rates specifically for their case.
Finding a Lender for the Loan
It is important for a borrower who is looking to get a home equity loan, to shop around for a lender. Home equity loans can differ in terms, conditions, and interest rates. Some lenders may offer better terms than others while all of them are offered based on the same information. Different lenders may have different objectives when it comes to issuing home equity loans, so it is important to check what different lenders have to offer. The largest players or best-rated home equity loan lenders may not be able to provide the best product for a specific financial situation because their products are limited in flexibility to adjust to the needs of a borrower. It is best to contact banks, credit unions, private lenders, and other players that could be interested in issuing a home equity loan. Once the borrower finds a lender who is willing to issue a home equity loan, the borrower can finally get the loan.
Getting the Loan
The last step to acquiring a home equity loan is providing all documentation to the lender, paying applicable fees, and receiving the money. This step should be quite straightforward because the lender is expected to help the borrower to complete the origination application. Some people may get surprised by the fees associated with the loan, but a borrower should expect to pay certain fees for originating any type of loan including a home equity loan.
Depending on the lender, the origination fee can have a flat structure or take a percentage of the principal. In addition to that, a borrower may be able to negotiate it down if they have enough negotiating power to do that. Many lenders also allow origination fees to be rolled over into the loan. In this case, the borrower would not have to pay any fees upfront, but they will amortize it with the rest of the loan as well as pay taxes on it. Once everything is paid up, the borrower can receive the money and pursue their next project.