A home equity loan (HEL), otherwise known as a second mortgage, is a secured loan that uses a fixed, tangible asset, in most cases your home, as collateral for the loan’s value. Home equity loans let owners obtain financing against the equity amount they have in their homes. This equity amount gets calculated through the portion of the house you own entirely.
Typically, HELs are a fixed rate, which is great when interest rates are low as you can lock in that rate for the next 5 to 30 years.
There are a few different ways to get a HEL. For example, you could go to a bank, credit union, trust company, or private lender.
Since your house is collateral for the loan, if you cannot make the appropriate repayments, lenders can take ownership of the equity of your house that you put up as collateral and sell it to get their money back.
The amount of time it takes to get a home equity loan will depend on the lender you go through. Some can process the application and have you funded within a week, while others may take up to a month. Keep in mind that the more complex your application is, the longer it may take for the lender to approve it.
What Are The Benefits Of A Home Equity Loan?
The benefits of home equity loans are vast. With access to higher lending amounts, better rates, and better terms, HELs utilize your home to the fullest. By using your home as collateral, banks and other lenders have a tangible asset to possess in the case of a default.
Home equity loans are a way to raise money to pay off existing debt, improve your home, or buy another property. If you have a stable income and know you can repay your loan, these low-interest loans are very logical.
Although interest rates on home equity loans are typically higher than a first mortgage, it is much lower than other forms of credit like credit cards or private loans. These low-interest rates are why HELs can be used as a form of debt repayment for credit cards. Finally, these “second-mortgages” tend to be fixed-rate, whereas alternatives are variable.Â
What Is The Average Timeline?
Frankly, there is no “average” timeline for people to get approved for home equity loans. Most major lenders will claim it takes two to six weeks to process an application. However, every borrower is unique, and certain conditions can quicken or lengthen the process.
Additionally, it depends on how much equity you’ve built on the house. If you’ve just purchased a home, it is unlikely you may have enough equity to qualify for the loan.
Some conditions like insufficient documentation, closing, appraisal, and even verification can extend the process for weeks.
What Are The Requirements?
Home equity loans and their respective lenders only lend out large sums of money. Spring Eq, for example, offers HELs starting at $25,000 and go all the way to $500,000. If you need allowances less than that amount, other forms of financing like credit cards, personal loans, or unsecured borrows may be better options.
Next, lenders look at specific metrics to see if the borrower is up to par with qualifications. Some of these metrics include:
- Equity
- Credit Score
- Debt-to-Income Ratio
Equity
Equity is the amount of the home that you already own. Essentially, how much of the primary mortgage you have paid off vs. what you still owe. Lenders look at the amount of equity you have already built with your house. Typically, it is required to have at least 15% to 20% of your home’s value paid down.
Calculating equity is quite simple. If your house is worth $100,000 and you have paid $20,000 for the mortgage, leaving $80,000 still unpaid, you have 20% equity in the home.
Credit Score
Another critical metric lenders look at is credit history. Like all loans, having a solid credit history will allow you to be eligible for better loans. Most lenders are okay with scores above 680, but to be safe, 730 is the golden standard for getting the best rates.
Debt-to-Income Ratio
Finally, lenders look at your Debt-to-Income Ratio, simply known as your income ratio. This metric lets lenders know how much of your income goes towards paying down debt. It is calculated by dividing monthly payments by your monthly income. On average, a sub 36% income ratio is eligible for HELs, but some lenders offer higher interest rates for those with income ratios as high as 50%.
How To Apply?
Getting approved for a Home Equity Loan is relatively smooth as it is backed by tangible assets and is therefore secured. The lender will determine your creditworthiness by looking at your credit history, assess your house value through an appraisal (which the borrower must often pay for), and with that information, can determine the terms of the loan.
1. Lender Selection
To start, you need to find the right lender who will work with you and that you are comfortable with. A great tool you can use to find the best HEL is Bank Rate. Their tool on Home Equity Loans shows you the best lenders to work with depending on your credit score and loan terms.
2. Check Eligibility
Once you’ve found a lender you are comfortable with, the lender will look at certain metrics to determine your eligibility. Once that is completed, they will move forward with the application process.
3. Paperwork & Appraisal
After the lender determines you are eligible for the loan, you now need to start preparing all the appropriate documentation required. This includes tax information, property information, income information, and more.
Additionally, lenders will require an appraisal of the property to be completed to ensure they have the correct information. This appraisal must be completed by a certified appraiser and will most often come at the borrower’s expense.
4. Underwriting
When the appraisal is completed, underwriting is the next step. Underwriting is the most time-consuming task as underwriters have to compare and analyze the financial details of the loan and see if they can get final approval.
5. Closing
Last but not least, closing. This is a relatively quick stage, as it is just finalizing signatures and arranging the funds. You now have your Home Equity Loan!
What Happens If I Get Denied?
If you get denied, you should never give up. Firstly, you should talk with your lender regarding the denial. Ask them why it got rejected. In fact, they are legally obligated (within 60 days) to let you know the reason for rejection. Using that information, you can change your finances, application, and other conditions.
In addition, you can always try out these solutions to try to get approved:
Additional Collateral
Banks and lenders may accept other fixed assets as collateral to be approved for the loan. However, this is very risky, as should you default, you will lose whatever you put up as collateral.
Get A Co-Signer
Like getting co-signed for a mortgage, co-signing for a home equity loan will allow you to get the loan even if your credit score isn’t up to par or your income ratio too high.
Test Different Lenders
Although you may think that being denied by one lender means all lenders will reject your application, lenders have different application processes and eligibility requirements. Therefore, it is important to try different lenders to see if they assess your financial situation differently and approve your application.
How To Repay?
With home equity loans, you receive the total amount in one lump sum payment. Once received, lenders will ask for fixed monthly repayments on the loan amount and will charge you a closing cost at around 2-5% of the total loan amount. In an effort to pay it off, it is essential to budget aside the appropriate amount every month towards the monthly payment obligations.
To be safe, we suggest setting aside an additional 5%-10% of your monthly loan amount to avoid any mishaps. Moreover, to ensure you don’t miss any important payments, your lender may allow you to set up pre-approved monthly repayments. Pre-approved monthly repayments will allow the lender to automatically collect the loan amount from your bank account.
Some Alternatives
If using your home as collateral doesn’t suit you, or you want to look at other options, we have listed some fantastic alternatives below:
- Refinancing (Cash): A cash refinance loan is where you take out a loan with better rates to pay off your first mortgage and keep the difference.
- Home Equity Line of Credit (HELOC): Similar and often misconstrued with Home Equity Loans, HELOCs are revolving sources of funds. They don’t have high closing costs like mortgages. However, they are typically variable interest rates. Moreover, HELOCs are structured with two phases, a draw period and a repayment period. The draw period is when you can withdraw from the line of credit, and the repayment period is when you have to pay the principal and interest for the amount you took.
- Personal Loans: Personal loans are unsecured loans that borrowers can take out for any purpose. Despite the higher interest rates, sometimes two to three times higher, personal loans give you flexibility in how you want to spend the money.
Key Takeaway
With various funding sources and options available, if you ever need the extra financing, home equity loans are a great option. HELs are secured to your tangible assets, most often your house. Home equity loans tend to have better terms than most other borrowing options as there interest rates are low and the amount of money you have access to is typically higher.
Regardless of the benefits, weighing the upside with the downsides is always important. Don’t blind yourself with how “easy” it may be to obtain home equity loans, as the more debt you pile on; the harder and harder it becomes to get out of it. In particular, when using your house as collateral, you must understand you may lose it if you cannot pay the required amounts.