Is it a mortgage? Or is it a personal loan? If you’ve been searching the market for a loan, you’ve probably come across the home equity loan.
What is a home equity loan? How does it work? And why would you want one? In this article, we answer all the important questions.
A home equity loan, commonly known as a HEL, is a type of loan in which the borrower uses their home equity as collateral. Home equity loans are commonly used to finance major expenses such as home repairs, debt consolidation, or medical bills.
A HEL creates a lien on the borrower’s property, giving the lender the right to possession of the property until the borrower pays off the HEL in full. Usually, the HEL is the second lien on the property (after the original mortgage), which is why HELs are also known as a “second mortgage”.
The HEL involves the transfer of a lump sum of cash from the lender to the borrower, effectively making it a type of secured personal loan. Therefore, to answer the question at the beginning of this article: a HEL is in effect a hybrid of a mortgage and personal loan. Home equity loans typically carry higher interest rates than mortgages but lower rates than unsecured personal loans.
A home equity loan is a fixed-rate, closed-end loan. This means it is paid to the borrower in a lump sum and the borrower must pay back that sum, according to a fixed annual interest rate, within the designated repayment term. Home equity loans tend to have shorter repayment terms than mortgages, although some lenders have been known to offer terms of up to 30 years.
Because a home equity loan creates a new lien on the borrower’s property, it also involves new closing costs. Closing costs on a home equity loan generally range from 2% to 5% of the value of the loan, although some lenders may waive a portion of the loan or the entire loan altogether. Closing costs include origination fees, appraisal fees, title fees, and a bunch of other fees that home owners will already be familiar with from their first mortgage.
The eligibility requirements for a home equity loan are similar to a traditional mortgage, with one major exception: with a HEL, the borrower must meet combined loan-to-value (CLTV) requirements.
In the U.S., lenders typically allow a maximum CLTV of 80% of 90%, meaning you can borrow up to 80% or 90% of your home’s value. The keyword here is “combined”, which refers to the fact that all other liens are included in the calculation. Let’s keep things simple and say your home is worth $100,000 and your mortgage balance is $50,000. In this case, your loan-to-value is 50%. Therefore, you may borrow up to an additional $30,000 to $40,000, bringing your CLTV up to 80% or 90%.
Aside from CLTV, the other major requirements are credit score and debt to income (DTI). As with a mortgage, the minimum credit score is usually 620 although some lenders may show more leniency due to the fact your property is being used as collateral. As for DTI, lenders typically allow borrowers to use up to 43-50% of their gross monthly income on loan payments.
Like a personal loan, a home equity loan may be used for any purpose. Because a HEL involves putting your home up as collateral, it is best used for large, unavoidable expenses or for taking steps to improve your property value or financial position, such as home repairs or debt consolidation.
A HEL is a secured loan and as such it removes some of the risk away from the lender and places it on the borrower. In return, lenders are willing to offer borrowers better rates than they would for an ordinary, unsecured personal loan. What’s more, HELs sometimes have looser requirements than personal loans and the repayment terms are longer.
Many borrowers don’t realize it, but if a home equity loan is used to buy, build or substantially improve the taxpayer’s home that secures the loan, the interest paid to the lender is tax-deductible.
Home equity loans are generally only offered by lenders that also deal with standard mortgages. Following is our list of the top three HEL lenders.
LendingTree is America’s largest online loans marketplace. It exists to connect borrowers with the best rates from hundreds of verified lending institutions from across the United States. It works with all types of loans, including home loans, personal loans, and home equity loans. With LendingTree, borrowers pre-qualify for multiple lenders with one single application. It only takes a minute – and it’s free!
If you’re looking for market-beating rates on a home equity loan, LendingTree is the perfect place to start. The secret to LendingTree’s success is competition. By gathering all the top HEL lenders in one place, LendingTree forces them to compete – which brings down rates and fees. Millions of people have obtained home equity loans via LendingTree, but even if you don’t it’s still a great place to begin your comparison shop.
Figure uses artificial intelligence and blockchain (the technology behind Bitcoin) to improve the home equity loan application process. By automating the entire process, Figure is able to approve HEL applications within minutes and get the funds to the borrower within five days. This makes it much quicker than most other HEL lenders.
Figure offers two types of loans: Home Equity Loan PLUS and Home Advantage. PLUS is a variation on home equity loans, offering loan amounts of up to $100,000, CLTV of up to 80%, low origination fees, and no ongoing or late fees. Home Advantage is a variation on reverse mortgages, which is basically a government-backed HEL for retired homeowners.
Quicken Loans was the biggest mortgage lender in the United States in 2018 with $82.7 billion worth of originations. It doesn’t offer home equity loans, but it does offer a popular alternative: cash-out refinance. A cash-out refinance is a way of cashing in when your home appreciates in value. It involves refinancing your original mortgage and cashing out the difference between your old loan and new loan.
Quicken Loans is really two businesses: the parent business, Quicken Loans, where borrowers can apply online or in branch; and a subsidiary, Rocket Mortgage, which offers extra-quick online mortgage and HEL applications. Whatever you’re looking for, Quicken offers plenty of expertise and educational materials.