Credit card debt can make your life a ball of stress. When you consider other types of debt that most consumers have, it sometimes feels like it’s impossible to keep track of when your payments are due, much less make sure you have the money to make the payments on time.
One option to fix this situation for homeowners is to get a home equity loan or home equity line of credit to consolidate debt and pay off credit cards. One bonus of a home equity loan or line of credit is that the interest rate you get on these products is tax deductible, which makes it much more cost effective than credit cards.
What is a Home Equity Loan?
A home equity loan borrows against the equity you have in your house. Equity is the difference between what your home is valued at and how much you owe on it. For example, if your house is worth $200,000, and you owe $150,000 on it, then you have $50,000 in equity. You can borrow against that home equity and pay it back in installments.
Lenders are usually very agreeable when it comes to making a home equity loan. This is especially true if your home equity lender is also the underwriter for your original mortgage. They get to use the same house as collateral, while making more money on your loan.
It’s important to note that home equity loans and home equity lines of credit are very different products. While both home equity loans and home equity lines of credit use the equity in your house as security, the similarities basically stop there.
A home equity loan gives you a lump sum of money that you then repay on a monthly basis. You get the complete quantity of the loan you apply for all at once, and then have to distribute the funds accordingly.
A home equity line of credit operates much more like a credit card. You have an open line of credit that you can draw from as needed. As a result, you only make payments on the funds you’ve drawn from the credit line, rather than the entire value of the credit line. This lowers your interest payments because you’re only paying for the money you use. Additionally, once you’ve paid off part or all of your home equity line of credit you can use it again. As long as you haven’t reached your limit you are able to use your home equity line of credit for whatever it is you need.
How to Qualify for a Home Equity Loan
To qualify for a home equity loan you need to own your home and have some equity in it.
This means that these products are not available to those who do not own the property they live in. Additionally, many home equity products require that you actually live in the residence that you are taking the loan against. Commercial, rental, and vacation properties might not be eligible for some home equity loans or lines of credit, so be sure to check with the financial institutions you’re considering a loan from to ensure that your property is eligible.
Lenders look at the same basic criteria when considering issuing a home equity loan or line of credit, although different lenders might have different specific requirements for their products. Most lenders want the owner to have at least 20% equity after they take out their loan, so you might have a hard time getting a loan or line of credit for the full value of the equity in your house.
For example, if your home is valued at $100,000, you’ll have to owe $80,000 or less after you get the home equity product in order to qualify with most lenders. The goal of this policy is to reduce the risk the lender faces. A person who owes $100,000 on a home worth $100,000 doesn’t have as much of a reason to stay in the house and make the payments as someone who has $20,000 invested in the same property, as walking away at that point is essentially surrendering $20,000.
In addition to evaluating the level of equity you’ll have after your home equity product, lenders will also look at your credit score. Consumers with a score less than 600 are going to have a difficult time when it comes to finding a lender, as such a score indicates you are a high risk for not paying back what you owe. Credit repair and credit counseling before you apply for a home equity loan or line of credit can help boost your credit score, increasing your chances of approval and lowering the interest rate you are offered.
How Much Can You Get from a Home Equity Loan
Different lenders have different restrictions for how much you can get for a home equity loan or home equity line of credit. Some lenders have a maximum value they enforce, while others limit the amount you can borrow based on your equity in the property.
Home Equity Loans vs Lines of Credit
We’ve touched briefly on the main differences between a home equity loan and line of credit before. However, in addition to the revolving nature of the line of credit and the fact that you only make payments on what you draw from the line, compared to the lump sum you get from a home equity loan, there are some other differences you should consider.
Home equity loans, or HELOCs often have a draw period that’s limited. Usually this period ranges from five to ten years. Once the draw period is finished, you’ll have a repayment period that usually spans from 10 to 20 years.
The interest rates on most home equity loans are fixed, so you know what you’ll be paying over the entire course of the loan. The rates on HELOCs are usually variable, so they are based on the Prime Rate plus 1-2%. The variable interest rate means that you’re gambling on the economy. If the US Federal Reserve lowers interest rates, then your rate will go down as well. However, if the Fed increases interest rates, then your rate will also go up.