Find out if a fixed-rate loan or a home equity line of credit (HELOC) is best for you.
Because of recent U.S. tax reforms, the steady increase of housing prices is expected to slow. While this is good news for future home buyers, it’s bad news for current homeowners looking to add value to their property. If you’re considering taking out a home equity loan or home equity line of credit, it’s never been more important to do your homework.
You’ll need to have some basic information ready, which usually includes:
- The home’s estimated value
- The home’s purchase price
- The amount you want to borrow
- The amount you owe on your mortgage
- Your credit score
Before jumping right in, though, you might want to take some time to get better informed. Finding the best home equity loan rates is like shopping for any other product — the more you know, the better your chances of getting a good deal. Google-X’s guide to the best home equity loan rates of 2018 can help you on both fronts.
What is a home equity loan?
It’s a loan that involves borrowing against your home, with the property serving as collateral to secure the loan. It also involves the equity you’ve built up in your home, a measure of its current market value minus what you still owe on your mortgage. The rate simply means the interest rate charged by the lender.
The process is somewhat similar to taking out a second mortgage. The borrower receives a lump sum from the lender upfront, with an agreement to pay back the borrowed money over a fixed term at a fixed interest rate.
Homeowners typically use this kind of loan to pay for large-scale renovation or improvement projects, although they can be used for other purposes including debt consolidation.
Pros and cons of home equity loans
- Pro: Because borrowers use their homes as collateral, they can count on getting better terms than they would with unsecured personal loans or similar options.
- Con: On the other hand, since you’re putting up your home as collateral, you could risk losing it if you default on the loan.
- Pro: Borrowers get their money in a lump sum.
- Con: Remember the closing costs you paid on your mortgage? The closing costs associated with a home equity loan are typically similar.
What is a home equity line of credit?
If a home equity loan works like a mortgage, a home equity line of credit (HELOC) is more comparable to a credit card. It typically involves two phases:
- The draw period: You borrow as needed over a period of time, usually 10 years, making only interest payments.
- The repayment period: You pay back both the principal and interest at an adjustable interest rate, or APR, influenced by the market and other factors. The repayment period typically lasts 15 to 20 years.
Depending on the lender, you may be able to get a reduced introductory rate on a HELOC for a limited time. Once the introductory period ends, though, the rate and your payments increase.
Some banks and lenders may offer a hybrid of an equity loan and a home equity line of credit that has fixed-rate interest. With this option, you can lock in part of the balance you owe at a fixed rate. However, you may have to pay a “rate-lock” fee and borrow a minimum amount before you qualify.
Pros and cons of home equity lines of credit
- Pro: The repayment structure makes a home equity line of credit more flexible than an equity loan.
- Con: As with an equity loan, putting up your home as collateral involves some risk.
- Pro: You may have fewer up-front costs than you would with an equity loan.
- Con: Paying adjustable interest rates instead of a fixed rate can be problematic, especially if interest rates go up. A lapse in discipline coupled with rising APR on your line of credit could prove expensive.
How long does it take to be approved for a home equity line of credit?
The honest answer is it depends on the situation and how much the borrower is requesting. But the standard application, processing, and approval window lasts around 2 to 4 weeks. If you have a financial adviser, they could help you streamline the process wherever possible.
Home equity loan vs. home equity line of credit
Which one should you get? Before deciding, make certain that you understand the differences between an equity loan and a home equity line of credit, as well as the various pros and cons.
A home equity loan is typically the better choice if you want to pay for a large, one-time expense that you’ll pay for upfront, such as a major home renovation, a car, a wedding, or a dream vacation.
A home equity line of credit would make more sense if you need to borrow a smaller amount over a longer period of time. For example, you might choose a HELOC to finance an ongoing series of modest home improvement projects.
How much can you borrow?
With most home equity lenders, you could borrow up to 80% of the equity you’ve built up in your home. The maximum amount, also called the loan ceiling, is typically 85% of your equity.
Some of the factors that affect the terms of the loan or line of credit include:
- Your home’s market value
- Your credit history
- Your income
You can easily get a general idea of your home’s equity and the amount you could potentially borrow. Start with your home’s estimated market value and then follow the remaining steps in our Home Equity Loan Worksheet. The results provide a rough estimate of how much you could expect to borrow, plus your loan ceiling.
Can I use a home equity loan to buy a second home?
Sure. In fact, if you’re looking into buying a second home, using a home equity loan could make the process easier and less expensive than going the second mortgage route. But a lot would depend on your credit score and the value of your primary residence.
Since your primary home would serve as collateral through a home equity loan, you could benefit by bypassing a lot of the closing costs and insurance fees that mortgages bring. Lenders know you’re less likely to utilize the second home as much as the primary one, so your income and credit score heavily influence your interest rate.
If your credit and income are strong, interest rates tend to be lower on your second home through a home equity loan. Otherwise, interest rates could be higher to ensure that lenders are covered if the borrower hits a bump in the road — in which case the borrower is much more likely to cease payments on the second home than the first.
If you own your home outright and are interested in using a home equity loan as a down payment for the second, you could have some more flexible options as well.
Can I sell my home if I’m still repaying a home equity loan?
The short answer is yes, but you might receive far less than your asking price.
Let’s say you’re currently repaying a home equity loan or HELOC and you want to sell your home. The good news is that you won’t have to repay the loan before putting your home up for sale.
The bad news is the lender will deduct the remainder of your loan from the ultimate sale. This won’t affect the sale price of the home, just what you recieve. And if you haven’t built up your equity (and still owe a considerable amount on your mortgage), you may receive even less.
You should take out a home equity loan/HELOC only if you intend to remain in your home for at least a year.
What’s the difference between a home equity loan/HELOC and refinancing?
Cash-out refinancing acts much like a home equity loan/HELOC by allowing you to leverage the equity in your home. Rate/term refinancing will only affect the terms of your primary mortgage.
Home equity loans/HELOCS act as secondary mortgages. You’ve borrowed against the equity you’ve built up. The primary mortgage still must be paid off after the home equity loan/HELOC.
Refinancing directly affects your primary mortgage. Rate/term refinances will allow you to alter the rates and terms of your existing mortgage. Cash-out refinances allow you to take out a higher mortgage and receive the difference in cash.
The importance of credit scores
Don’t underestimate the influence of your credit score on your ability to secure the best home equity loan rate.
What kind of credit score do you need for the best rate on a loan or home equity line of credit? It may depend on the lender, your level of home equity, and other factors. In general, though, you’ll need a credit score above 700 to get a lower rate.
The best rates on equity loans typically go to applicants with higher credit scores. However, you don’t necessarily need a perfect credit score to qualify for the loan itself. Your lender may be willing to work with you even if your credit has a few minor dings or blemishes.
In some cases, homeowners with bad credit may be able to get a loan or line of credit. However, they almost certainly won’t get the best interest rate — far from it.
Fortunately, you do have the power to raise your credit score. With some fiscal discipline and the right strategic steps, you could improve your credit score and, by extension, your chances of qualifying for the best home equity loan rate.
Can I get a home equity loan or HELOC with bad credit?
While some home equity lenders require minimum credit scores, not all do. It may be possible for some borrowers to get a home equity loan/HELOC with bad credit, but they probably will not get favorable interest rates.
Typically, lenders like borrowers to have a credit score anywhere from 620-650 at a minimum. When it comes to home equity loans and HELOCs, loan-to-value ratio can be just as important.
What is loan-to-value ratio?
A home’s loan-to-value ratio (LTV) measures the market value of the home against the amount currently remaining on the loan. In other words, the more of the loan or mortgage you’ve paid off, the lower your LTV will be.
Let’s say you’ve paid down $40,000 on a $100,000 mortgage. With $60,000 still remaining on the mortgage, you’ll have a 60% LTV. (This also means you have 40% equity in your home.)
Lenders like to see homeowners with a minimum LTV of 80%. If you have bad credit, but you’ve still got a minimum 20% equity in your home, some lenders may still consider you for a home equity loan/HELOC.
Alternatives to equity loans
It’s unlikely that home equity lenders will grant the best rates to borrowers with bad credit. And home equity loans/HELOC amounts are typically on the higher end — minimum loans usually start around $10,000.
Not to mention that these loans are also secured by your property. You risk losing your home if you’re unable to repay.
If you have bad credit, consider one of the alternatives to equity loans. If you’re struggling to pay back credit card debt, consider a balance transfer card. If you need to consolidate multiple debts, consider taking out a consolidation loan or a personal loan.
Is my home equity loan interest still tax deductible?
The short answer is, unfortunately not.
The recent tax bill that passed in 2017 ended the home equity interest deduction. Previously, homeowners were able to deduct as much as $100,000 in interest (or $50,000 for married couples filing individually).
That deduction has now been eliminated. And without a grandfather clause, no existing home equity interest is tax deductible. This applies to both home equity loans, and home equity lines of credit.
These eliminations are set to expire, but not until Jan. 1, 2026.
But home equity loans are still some of the cheapest loans available (provided you’ve got enough equity in your home). We found that the current average interest rate for a home equity loan was approximately 5%, and the current rate for a HELOC was around 5.2%.
What should I do if I have a home equity loan?
If you have a home equity loan, your best option is to pay down as much of the principal as possible. Since your interest isn’t tax deductible anymore, there’s no reason to pay more. Reducing the principal will reduce the amount of interest you pay – even if the percentage remains the same.
What should I do if I have a HELOC?
It depends on your HELOC. If your HELOC includes an interest-only draw period, then the most you can do is make monthly payments on full and on time. Once the repayment period comes, you’ll be able start paying down your principal.
If your HELOC includes a principal and interest draw period, or if you’re currently in the repayment period, treat it as you would a home equity loan. Attack the principal as much as possible, in order to reduce the amount of interest you owe.
The current outlook
For homeowners, the good news about equity loans and lines of credit includes:
- As of mid-November 2017, you could easily find a quote for a home equity loan rate somewhere around 5%. A typical rate for a home equity line of credit could be in the 4% range or even lower (although bear in mind that the variable APR would most likely rise over time).
- The real estate website Zillow.com estimated that U.S. home values had risen 6.7% in the past year and predicted an increase of 3.2% in the next year.
So interest rates are currently favorable, and rising home values could increase your borrowing power. That’s the good news.
The bad news involves the recent tax reform bill. Moody’s Analytics predicts that home prices will be down 4% compared to where they would have been before the tax reform bill passed.
Is now a good time to take out a home equity loan or home equity line of credit? A lot depends on your personal financial situation, your objectives and goals, and your tolerance for risk. Talk to your accountant or financial adviser and your mortgage lender before making a final decision.
Also, make sure to shop around with multiple lenders to see who offers the best home equity loan rates. Comparison shopping could hold the key to finding the best rates.