How to Get a Home Equity Loan

How to get a home equity loan
Peter WardenJun 12, 2022
Key Takeaways:
  • To get a home equity loan, you need home equity, decent credit, and a steady income.
  • You can find home equity loans at banks, credit unions, mortgage companies, and other institutions.
  • Compare home equity loan offers before committing to a lender because rates and fees vary.

Wondering how to get a home equity loan? You need to follow these steps:

  • Estimate your home equity.
  • Get your credit report and score, income, and bank statements.
  • Compare home equity loan offers and choose a lender.
  • Apply for loan approval.
  • Close your loan and get your money.

It can take two to four weeks to get a home equity loan if your lender requires a home appraisal, so if you want money from your home, plan to start soon.

We’ll explore each of those bullet points in more detail. So read on for tips to improve your chances of getting both approved and a low interest rate.

How Does a Home Equity Loan Work?

Home equity loans are basic. You use some of the equity you have in your home as security for a new installment loan. Let’s run through some of that jargon to make sure everything’s plain.

What is home equity?

The equity in your home is the difference between your home’s present market value and your current mortgage balance. 

How do you calculate home equity?

There are two ways to look at home equity – as an amount (like homeowners do) and as a percentage (like lenders do). Suppose you bought your home several years ago, and today it’s worth roughly $410,000, which was close to the national median sales price for a residential property at the end of 2021.

Meanwhile, your monthly payments have been reducing your mortgage balance. And, today, that balance is $260,000.

To find your home equity, you simply subtract your mortgage balance from your home’s value: $410,000 - $260,000 = $150,000.

A mortgage lender looks at your equity this way: first, divide your current mortgage balance by your current property value. $260,000 / $410,000 equals 63%. That’s your loan-to-value ratio or LTV. Subtract that from 100% and you see that you have 37% home equity. 

Retained equity

However, your chances of finding a lender that will let you borrow against all $150,000 with a home equity loan are tiny. Some will want you to retain 20% of your home’s value as equity, although others will approve loans up to 90% of your property value if you’re highly qualified. 

Let’s be pessimistic and assume you have to retain 20% of your home’s value as equity. On $410,000, 20% is $82,000 ($410,000 x 20% = $82,000). 

So, in this example, you can borrow only $68,000. That’s your $150,000 equity less the $82,000 that you must retain. ($150,000 - $82,000 = $68,000).

Another way to look at this is by multiplying your home value by 80% and then subtracting out your current loan balance. $410,000 * .8 = $328,000. $328,000 - $260,000 = $68,000.

What is “security?”

You’re putting up your home as security (or “collateral”) when you borrow a home equity loan. In other words, if you fall too far behind on your payments, the lender can foreclose on your home to recover the debt.

That applies equally to home equity loans and home equity lines of credit (HELOCs). They’re both second mortgages secured by your home. 

This is serious if you aren’t confident you’ll keep up with your payments. You may prefer to apply for a personal loan, which would not trigger a home foreclosure if you can’t pay it back.

What is an “installment loan?”

An installment loan provides you with a lump sum that you repay in equal installments over a fixed period. Nearly all home equity loans come with a fixed interest rate. That fixed rate means every payment will be the same over the entire loan term. 

So fixed-rate installment loans rarely create nasty surprises. And budgeting for them couldn’t be easier.

How to Estimate Your Home Equity

We already covered how to calculate your home equity, above. And the first step couldn’t be more straightforward. You simply check your mortgage balance online, call your lender or consult your most recent statement. 

But that’s only half the job. Because you also need a good idea of how much your home is worth. Eventually, an appraiser will have the final say. But it would be best if you had a realistic figure in order to decide whether you want to apply for a home equity loan.

The more effort you put into estimating the value of your home, the more accurate that estimate is likely to be. And we suggest you do all or most of the following:

  1. Ask a local real estate agent for a CMA, or “comparative market analysis” – If she thinks she’s going to get your business when you eventually sell, she might do this for free or for a nominal fee.
  2. Check online home value estimators – Understand that these aren’t magic and may be off a lot if you’ve upgraded your home or if it’s very unique. So look at several and take them with a grain of salt.
  3. Consult other online sources – Your county or city may have a searchable database of recent home sales in your neighborhood. The Federal Housing Finance Agency’s House Price Index (HPI) calculator can provide data on how home prices are trending where you live. And the Multiple Listing Service can show you listing prices (but, critically, not sales prices) for local homes for sale. Be sure to compare apples with apples

Once you have the most accurate estimate of your home’s value possible, you simply subtract your mortgage balance. The difference is your home equity. Just remember, you’ll need to retain a chunk of it.

Credit Score and Income Needed for a Home Equity Loan

As with all borrowing, lenders of home equity loans want to be sure that you’re ready, able, and willing to make timely payments.

They look to your credit score to see that you’ve been a responsible borrower and managed debt well. That suggests you’re willing to make payments.

Other factors indicate that you’re ready and able to do so. So they check how much of your monthly income goes straight out again on homeownership costs, debt payments, and things like alimony and child support. This is your debt-to-income ratio (DTI) and it shows whether you have enough disposable income each month to comfortably afford your loan payments. 

Lenders also like to see that you have a consistent and reliable income, backed up by a solid employment record.

What you might need to get approved

Each lender sets its own rules about credit scores, DTIs, and other qualifying criteria. And many will allow you to be a bit weaker on one if you’re stronger on another. For example, if your credit score is a bit shabby, you might still get approved if your DTI is lower than most. 

All this makes it impossible for us to give you firm guidance that will apply to all lenders. But Experian, one of the Big Three credit bureaus in the U.S., suggests these typical requirements for home equity loans:

  • Credit score – 680 or better. But 660 may be possible. And 700 or higher will almost assure approval and earn you a lower interest rate
  • DTI – No more than 40% to 43% of your monthly gross income 
  • LTV – If your retained equity is 20% of your home’s value, your loan-to-value ratio (LTV) is 80%. (Your total borrowing secured on your home is 80% of its value.) Some lenders may allow a higher LTV. But you may need a lower LTV if your credit score and DTI are weak
  • A reliable income based on a solid employment history

If you don’t come up to scratch in these respects with one company, search out a more sympathetic lender.

How to Shop for a Home Equity Loan

As with mortgages, auto loans, and other types of borrowing, interest rates and overall deals on home equity loans vary widely between lenders. So it’s essential you seek out a lender that offers you the lowest rate and closing costs you can get.

By all means, begin by getting quotes from your bank or credit union and existing mortgage lender. But cast your net way wider than those. The more financial frogs you kiss, the better your chances of finding your lending prince. 

And don’t worry about your credit score in this respect. Federal regulator the Consumer Financial Protection Bureau says, “Getting multiple Loan Estimates won’t hurt your credit, so long as you get them all within the same 45-day window.”

We can get you started by introducing you to lenders who might like to work with you.

Applying for a Home Equity Loan

A home equity loan is a second mortgage. And you’re likely to encounter similar administrative demands to those you faced when you applied for your primary mortgage.

If you’d like your money soon, it’s useful to compile all the documents your lender’s likely to require before you apply. Experian has a checklist

Of course, if you’ve time before you plan to apply, you could try to get into better financial shape. That should improve your chances of getting approved and could earn you a lower interest rate. 

For example, paying down your credit card balances should boost your credit score and inch your DTI lower. You might also raise your home’s value by tidying up the interior and exterior (just cleaning, decorating, and minor repairs) and making the yard as attractive as possible.

Home Equity Loan Appraisal

Traditionally, lenders almost always wanted an appraiser to inspect your home and provide a valuation. But COVID-19 made in-person visits undesirable. 

And lenders got used to relying on: 

  1. Drive-by appraisals – Where the appraiser doesn’t come inside and may not get out of his car
  2. Desktop appraisals – Where the appraiser never leaves the office and remotely checks online sources such as tax records and the MLS
  3. Automated Valuation Models (AVMs) – Where the whole thing’s done by computer using sophisticated algorithms. If you’d like the gory technical details, read this.

AVMs are cheap and easy. And your lender may be happy with one, especially if you retain a lot of equity and have a low LTV. But they don’t typically take account of all the features and finishes that make your home special – and therefore more valuable.

So, if you want a loan with a borderline LTV or you have a low credit score, you may be happy to tell your lender you’ll pay the cost of a full, traditional home appraisal. According to HomeAdvisor, that was, in early 2022, within a typical range of $313 and $420 for a single-family dwelling.

Denied? Alternatives to Home Equity Loans

Because home equity loans are “secured debts,” they typically have much lower interest rates than unsecured borrowing. So don’t be put off if one lender declines your application. Try other, more sympathetic ones. 

But what happens if you’ve kissed every home equity frog you can find and they all turned out to be wholly unroyal amphibians? You’re far from out of options. Here are three:

  1. Personal loans – These are similar to home equity loans, except they’re unsecured (no LTVs) and tend to have higher interest rates. However, set-up costs are often zero.
  2. FHA 203K Rehab loan – This only works if you want a home equity loan to fund a home improvement project. It’s easier to qualify and you’ll probably get a low rate. But closing costs may be high.
  3. Debt management plans (DMPs) – If you need to borrow to consolidate your debts. Over time, you could see your DTI fall and your credit score rise. Just be sure to choose a reputable partner.

Think carefully about how you proceed. Having your application declined might be a red flag that is warning you to review your financial circumstances. So take that seriously.

Summing Up How to Get a Home Equity Loan

Generally, American homeowners are rolling in home equity to an unprecedented extent. Here are some startling statistics from CoreLogic, a company that constantly monitors and analyzes home equity. By the last quarter of 2021:

“CoreLogic analysis shows U.S. homeowners with mortgages … have seen their equity increase by a total of over $3.2 trillion since the fourth quarter of 2020, an increase of 29.3% year over year.”

Note, that doesn’t mean American homeowners now have $3.2 trillion in home equity. It says their home equity increased by $3.2 trillion over the single year ending in the last quarter of 2022.

So many of them don’t need advice about how to get a home equity loan. Leaving aside the administrative slog, they’ll find it easy to qualify and access serious quantities of cash, which they can use for any purpose they choose.

But, of course, not every homeowner is so lucky. Some have hit on hard times financially. And others have missed out on such high home price appreciation because they live in areas where those prices have been stagnant or sluggish.

For them, getting a home equity loan may not be so easy. But other choices may be nearly as good.

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