When you need money for a large expense—maybe it’s for a remodel or to pay unexpected bills—you might wonder what your options are. Have you thought about utilizing the investment you’ve made in your home? If you’ve owned your home for years and it’s worth more than you owe, it means you have built up home equity. Getting a loan for home equity may be the perfect path to finding the funding you need. But what does that look like? Is it the right step for you?

What Is a Home Equity Loan?

Home equity loans are sometimes referred to as a second mortgage. Loans for home equity allow homeowners to borrow against the equity value of their homes. The lender bases the loan amount on the difference between the home’s current market value and the homeowner’s mortgage balance. Generally, lenders will let you borrow up to 80 percent of the value you currently have in your home.

Home equity loans allow you to receive a lump sum. They typically come with a fixed interest rate and carry a term of 5, 10, or 15 years. Once you receive your lump sum, you need to repay the loan monthly, similar to your first home mortgage.

Advantages of a Home Equity Loan

For many homeowners, loans for home equity are a lifesaver. They can be a great solution if you’re sitting on cash equity.

Home equity loans offer lower interest rates than personal loans or borrowing with a credit card because you use your home as collateral. Depending on how much equity you have, you may also have access to larger lump sums compared to personal loans or credit cards. This can be beneficial if you have a one-time large purchase.

Home equity loans also give you a greater degree of flexibility. They can be used for anything. You’re taking the cash you’ve built up over the years and using it at your discretion. Pay for that once-in-a-lifetime trip you’ve been dreaming of. Remodel your kitchen. Invest in a vacation home. Or pay for your child’s college education. It’s up to you where the money goes.

Of course, you should remember that your home is used for collateral. Sudden life changes won’t change the fact that you’ll owe the amount borrowed. A sudden job loss or a medical emergency can increase your risk. If home values decline, you could also end up owing more than the home is worth.

Want Something More Flexible? Try a HELOC

Loans for home equity have their benefits, especially if you need a one-time lump sum. Yet, in other cases, you may wish to have access to money as needed.

That’s where a home equity line of credit (HELOC) might be a better choice. HELOCs are also secured by your home, but they work a little differently than home equity loans. Instead of receiving a lump sum, HELOCs give you an open line of credit, allowing you to borrow what you need as needed.

Typically, HELOCs remain open for a fixed term; 10 years is common. When this term is over, any amount borrowed is amortized, and you continue paying for the set repayment term. The main benefit of HELOCs is you only pay interest on what you borrow.

Let’s say you need $40,000 over four years for your child’s education. Instead of taking a lump sum at the beginning and being assessed interest for the entire $40,000, a HELOC allows you to take $10,000 each year, keeping your interest payments lower. Interest would rise gradually with each draw you take.

How Do You Qualify for a Home Equity Loan or HELOC?

When you apply for home equity or HELOC, lenders look at two critical factors to determine your interest rate: your credit score and your existing debt. By knowing this ahead of time, you can improve your situation and compare offers to get the lowest interest rate possible on whatever home equity loan you decide to get.

Start by learning your credit score and improve it as necessary. It’s easier than ever to learn your credit score. Most credit card companies offer you the chance to learn your credit score for free. While this doesn’t provide a comprehensive look at your credit report, it allows you to discover your credit score and how you fall in rankings.

Creditors set their own standards for what qualifies as a good credit rating, but general guidelines state:

• A score of 740 or higher is excellent.
• A score between 700 and 739 is good.
• A score between 630 and 699 is fair.
• A score below 629 is poor.

If you can increase your credit score to a better range—fair to good, for instance—you may be rewarded with a lower interest, rate which could benefit you over time.

If necessary, you can also calculate your debt-to-income ratio and pay off any debt to improve your score. Approval is based on your property as collateral. Lenders are a little more lenient with credit scores because they have the property to back them up. However, your debt-to-income ratio can affect your interest rate, as it shows your risk level for payback. Paying off debt and avoiding new debt will work to lower the interest rate you pay on your new home equity loan.

Cash-Out Refinance as an Option

You may have another option if an equity loan or HELOC isn’t for you. Cash-out refinancing replaces your existing home mortgage with a new one, giving you access to the difference between the two loans in cash. The cash amount received is based on the value of equity you’ve built up in your current home.

A cash-out refinance means you’ll no longer have your original mortgage loan. Instead, you’ll pay off the existing home mortgage and replace it with a new one. People usually use a cash-out refinance when new interest rates are lower than the current home mortgage or if they choose a shorter loan term for an earlier payoff. Your new loan amount will be determined based on how much equity you decide to cash out.

Which Loan for Home Equity Is Right for You?

Choosing the right home equity financing depends on your unique situation. HELOCs have lower interest rates and greater payment flexibility, but they may not be your best choice if you need all the money immediately.

If you’re trying to decide what financing is right for you, it may benefit you to start doing your homework early. Capital Credit Union will guide you from beginning to end and simplify the process.