Home Equity Loan: What It Is and How to Use It
First of all, a home equity loan should not be confused with a home equity line of credit. With a home equity loan, you will receive a lump sum amount of cash that you can use for anything you want. In contrast, with a home equity line of credit, you will have a revolving line of credit that you can withdraw and replenish whenever you want. Both loans are secure against the equity of your home that is slowly built as you start paying off your mortgage. Once you have enough, you can use it as collateral to secure funds. In this blog, we discuss what is home equity loan is and how you can use it.The workings behind home equity loan
In principle, a home equity loan is similar to a mortgage. The equity of your home serves as collateral for the lender. The amount that you would be allowed to borrow will be based partially on a combined loan-to-value ratio of 80% to 90% of the home’s appraised value. As a borrower, you will be making regular payments that would cover both principal and interest. Of course, the amount of the loan and the interest rate charged will depend on your credit score and traditional home equity loans have a set repayment term. With a home equity loan, you can convert the equity you’ve built up in your home into funds. Especially, if you invest that cash in renovations for your property, it can increase the value of your home. You can use the funds to pay off bad loans and credit card bills as well.Home equity loan requirements- What you should know
Just like other loans, you will need to meet some criteria for your home equity loan as well. Lenders, generally consider some of the following factors when they will be reviewing your application:- Home equity: You will have to have a certain amount of equity built up in your home before you can apply for your home equity loan. Most lenders will require you to have already paid off at least 15% to 20% of your home's total value to qualify.
- Debt-to-income ratio: One of the important factors that will determine whether you qualify for a home equity loan is your debt-to-income ratio. Ideally, it should be less than 43% of your monthly income. For proof of your income, you can submit your paystubs and tax documents.
- Credit history: Your credit score should be between 600-750.
Home equity loan vs line of credit
Two of the major differences that you have between a home equity loan and a line of credit are:- A home equity loan will allow you to borrow a lump sum amount of money against your home's existing equity.
- HELOC also leverages your home's equity but allows you as a homeowner to apply for an open line of credit. With this revolving line of credit, you then can borrow up to a fixed amount when you need it.