Loan Types
Home Equity Loans
& HELOC’s
Home Equity Loans and Home Equity Lines of Credit (HELOC) are loans that borrowers can take out if they need cash in hand for certain expenses. Home equity loans can be very useful if you use them correctly, and detrimental if you do not. Home equity loans can help borrowers if something unexpected happens in their life such as a medical bill, or pay off a big life event such as a marriage or pay off student loans.
These loans are also often used for home renovation projects such as kitchen remodeling or installing a swimming pool. A key advantage of using a Home Equity Loan is that they come with lower interest rates than credit cards or other forms of financing.
Home equity loans can still be detrimental if they are used incorrectly, and unfortunately, there is a term for it called “reloading”. Reloading is the practice of taking out more debt to pay off the debt that you already have. This can become a scary debt cycle that some people do not know how to get out of. This can eventually lead to borrower’s taking out a home equity loan worth more than their home’s value. While it is true that renovating your home could add to its value, but if something happens in the housing market, that increase in value could still be a decrease compared to the value when you took out the loan, effectively leaving you in the hole.
Lenders can allow qualify borrowers to get a line of credit that is 60-85% of the value of their current equity. HELOC’s come with draw periods, which are the timeframes the borrower’s can use their HELOC money. During these draw periods, the borrower is typically only required to make interest payments. HELOC’s just like home equity loans, can be risky or helpful depending on how you use them. HELOC’s can be beneficial for paying off credit card debt.
One of the major advantages of a HELOC is the flexibility associated with them. If a borrower takes out a $100,000 loan, but only uses $50,000 of the balance during the draw period, they are only responsible for the $50,000 they used. Similar to a credit card with a limit of $10,000, and you make $2500 in
purchases. Another advantage is the large amount of money that a borrower can take out, depending on how much equity they have. HELOC’s also have lower interest rates than credit cards or unsecured loans.
There are also some disadvantages of HELOC’s. For one, you are risking your home because you are using it as collateral for your line of credit. If you default on your HELOC you could lose your home. Another disadvantage is that you are reducing your equity. A line of credit also causes your payments to increase suddenly. When your draw period is over, you now have to pay off the loan principal instead of only having to make interest payments.
To qualify for a home equity loan, the borrower will need a credit score in the mid-600s, but lenders will typically prefer a credit score in the 700s. They will also need a debt-to-income ratio of below 43%, and have enough equity in the home to access while staying below the 80% loan-to-value ratio. Qualifying for a HELOC has similar requirements. Lenders will typically require a credit score of 680 and a low debt-to-income ratio. Lenders will also make sure borrowers have reliable employment histories, as well as any financial problems borrowers may have had in their recent history.