What Are Home Equity Loans?

A home equity loan allows you to use your home equity as collateral, giving you a lump sum cash payment.  You pay back the full amount of the loan in monthly payments, which are made up of principal and fixed-rate interest.

The more equity you have in your home, the more you may be approved to borrow. In some cases, a home equity loan allows you to borrow up to 80% or 85% of your home’s value, with a deduction for what you still owe to your mortgage lender. 

Before applying for an equity house loan, make sure it’s the right decision and confirm you can afford this second mortgage payment. 

Eligibility for a Home Equity Loan Explained 

Qualifications for a home equity loan will vary by lender. In general, you need at least: 

  • 15% to 20% equity in your home
  • A credit score in the mid-600s
  • A debt-to-income ratio that is not over 43%
  • Reliable payment history
  • Sufficient income that shows you can repay the loan

Lenders may also require you to get an appraisal to accurately determine the value of your home and how much you might be eligible to borrow. 

With most lenders, you’ll need at least a 620 credit score to qualify. For the best rates, you need an excellent score of 740 or higher. Your-debt-to-income ratio, which compares what you owe to what you earn, impacts your credit score and loan eligibility as well.  

Alternatives to Home Equity Loans

If you find that a home equity loan is not right for you, there are other alternatives you can consider pursuing:

Home Equity Lines of Credit (HELOCs)

One alternative home equity loan option is a home equity line of credit (HELOC). A HELOC is similar to a credit card in that you have a credit limit and can withdraw what you need up to the specified limit. There’s an initial draw period, typically no longer than 10 years. As you pay down your balance, you can use it again, up to the limit, during the initial draw period. 

During the draw period, HELOC repayment is either interest-only payments or a combination of principal and interest. Choosing the second option means you’ll repay the HELOC faster. Interest rates on a HELOC are usually variable, which means your payments could increase or decrease throughout the repayment period.  

Once your initial draw period ends, you will need to repay the remaining interest and principal. Your repayment period will be somewhere between 10 and 20 years.

Home Equity Investment (HEI)

Point offers another alternative to a home equity loan called the Home Equity Investment (HEI). You could be eligible to receive anywhere between $35,000 and $350,000 without any monthly payments. Point becomes an investor in your home, allowing you to pay down your existing debts and still maintain control over your home. 

You can purchase back your equity at any time during the term, which is 30 years. Options to buy back your equity include a home loan, refinance, or sale. You can do a buyback as early as you like, with no prepayment penalty. 

Your buyback cost will vary based on your home value. The total is calculated based on the amount you originally received and a portion of your home’s appreciation since partnering with Point. In situations where your home appreciated beyond a certain amount, your costs will be capped. If your home lost value during the term, your buyback cost would be lower. 

Cash-Out Refinance 

A third option is a cash-out refinance. A cash-out refinance means you refinance your current mortgage into another one with a higher balance. You receive the extra money as a lump sum payment that can be used for whatever you need. 

Some people prefer a cash-out refinance over a home equity loan because it’s a single monthly payment. However, cash-out refinances have their downsides, too. They can be costly, and you must pay closing costs. If your home is only worth slightly more than you owe, a cash-out refinance likely won’t benefit you. Refinancing also restarts the clock on your mortgage, which means you’ll have increased monthly payments and be primarily paying interest for some time. 

Although there are differences between home equity loans and refinancing options, both can be useful financial tools for homeowners who have equity built up.

Pros and Cons of Home Equity Loans 

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There are pros and cons to home equity loans that you should consider before deciding which option is right for you.

Potential pros of a home equity loan include: 

  • You might have a lower, fixed interest.
  • You have the ability to use the proceeds for any needs you have.
  • You might gain tax benefits if you use the loan to improve your home.
  • You can usually get more funds than other loan types.

Potential cons of a home equity loan include: 

  • You are required to borrow a lump sum.
  • You won’t qualify if you have poor credit or too much debt.
  • Your home is at risk since it’s used to secure the loan.
  • You may need a co-signer to qualify.

Approval is not guaranteed, and lenders have become more cautious since the housing crisis in 2008. Because the loan is secured using your home’s equity, it’s important to weigh your decision carefully. If you have a major change in your life situation, such as losing your job or suffering a severe injury, you could fall behind on your mortgage. If that happens, your home could go into foreclosure. 

Which is Better: Home Equity Loan, Refinance, or HELOC?

Determining which option is best will depend on your circumstances. If a home equity loan, refinance, or HELOC isn’t right for you, consider a home equity investment from Point. Because the qualification requirements are more flexible than other lending options, people with less-than-perfect credit may qualify. 

Leveraging the equity in your home can allow you to complete a home renovation project, pay off other bills, do home repairs, or even take a hard-earned vacation. To learn whether a home equity investment is right for you, contact the team at Point. We can help you determine how much you can qualify for and the best way to leverage your home equity so you can meet all of your financial goals. 

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