Frequently Asked Questions About Home Equity Loans
What is a home equity loan?
A home equity loan is a loan that allows you to borrow money against your home’s equity. Your home’s equity is the difference between your home’s current value and your mortgage’s outstanding balance. The loan payments are added on top of your mortgage balance, which is why a home equity loan is often called a “second mortgage.” Use our home value estimator calculator to get an idea of how much your home could be worth in your area.
A home equity loan allows you to access money that would otherwise remain tied up in your property and unavailable for use. It can be a great way to fund home remodeling projects, take care of unexpected medical bills, consolidate debt, pay education costs or get you through periods where income may be tight.
How does a home equity loan work?
When you take out a home equity loan, the funds are generally dispersed in a lump sum and paid back in regular fixed installments over a predetermined amount of time (your term).
Once the home equity loan is finalized, the lender gives you the entire borrowed amount all at once. Then, as with any standard mortgage, you will make monthly payments, which include both the principal of the home equity loan, as well as interest.
How much your payments will be depends on a range of factors, including the interest rate and term. Loans with shorter terms, such as a 10-year loan, will typically have higher monthly payments, but the total interest paid will be lower over the life of the loan compared to those with longer terms.
Will the home equity loan help me build more equity or save money in other areas?
Using a home equity loan to pay for home improvements can increase the home’s value and equity. For example, adding a bedroom increases the home’s square footage and seller market price – thus, allowing you to walk away with more money in your pocket. Additionally, you may have the opportunity to deduct the home equity loan interest from your taxes, helping you save money.
What if I decide to sell my property before I settle the home equity loan?
If you sell your home before you pay off a home equity loan in its entirety, be sure that the proceeds cover both your primary mortgage balance along with your home equity loan balance. Anything owed on the home will need to be paid off to complete the sale.
Is home equity loan interest tax deductible?
Home equity loan interest may be tax deductible, provided that your total mortgage debt is $750,000 or less, you itemize your deductions and you apply the loan towards substantial home improvements.
Consult a tax adviser for further information regarding the deductibility of mortgage interest and charges.
What documents will I have to provide to obtain a home equity loan?
Similar to applying for a mortgage, you will be required to provide all necessary documents in order to qualify for a home equity loan. You are also responsible for closing costs, though you may have the option to roll some costs into your loan amount.
The documentation you are required to provide includes the following:
- E-sign loan disclosures
- Income documentation to support stated income
- W-2 wage earners: W-2s and pay stubs
- Self-employed: Two years of tax returns (business/personal or both)
- Retired: Proper award letters, 1099s and/or bank statements, etc.
- A credit report
- Bank statements
Do I qualify for a low-interest home equity loan rate?
Qualifying for a low-interest rate for your home equity loan is dependent on your credit score, debt-to-income (DTI) ratio and payment history. Your credit score indicates your creditworthiness and the likelihood you will repay a debt, while a debt-to-income ratio compares monthly debts and payments to pre-tax monthly income. You can calculate your individual debt-to-income ratio using the following equation:
DTI = Total Monthly Debt Payments / Gross Monthly Income
The bottom line is borrowers with a higher credit score and a good debt-to-income ratio have a greater chance of qualifying for a home equity loan with a low-interest rate.
Why is a home equity loan considered a budget-friendly financial solution?
If you need a specific amount right away and don’t want to risk overspending, a home equity loan can be a reliable solution that is also relatively easy to budget for — the fixed payment plan will help ensure that you know exactly how much you will owe towards the loan every month until it’s fully settled.
