A home equity loan is a type of loan in which the borrower uses the equity of the home as collateral. The loan amount is dictated by the value of the property, which is generally determined by a licensed appraiser, along with the balance on the current mortgage. Home equity loans are often used to finance major expenses such a home repairs, medical bills or college education. A home equity loan creates a lien against the borrower’s house.
Home equity loans come in two types: A fixed home equity loan (closed end) and a home equity line of credit (open end). Both are referred to as second mortgages because they are secured against the value of the property, just like a traditional mortgage. They may provide access to larger amounts of money than other types of personal loans.
Fixed Home Equity Loan: If funds are known for an exact or near exact amount and you desire to pay off the loan within a set period of time, a traditional or fixed home equity loan makes sense. Monthly payments which include both principle and interest will begin with your first payment due date and remain consistent throughout the term of the loan.
HELOC Loan: If an exact amount is unknown or if you desire funds for future access, then a HELOC makes sense. HELOC loans provide flexibility and interest-only payment options.
Most Home Equity loans require good to excellent credit history and reasonable home loan-to-value ratios. Generally, a minimum credit score of 620 is required for approval.
The loan-to-value ratio is limited to 80% (mortgage amount + home equity amount divided by the home value) on all types of homes and use. This includes primary & secondary homes and single-family homes & condos.
As with most loans, your income must be verified and your income along with other liabilities will be taken into account to determine your ability to repay the loan in full.
With either a fixed home equity or a line of credit, you’re pledging your home as collateral, meaning if you don’t make payments on your loan the lender could end up owning your home. Equity loans and lines of credit often have a repayment period of 15 years, although it might be as short as five. Even if you end up selling your house, you still have to pay off the balance of the loan before the lien on your home would be released.