10 home equity loan facts to know before you apply

We all need to borrow money occasionally, and there are many ways to do it. A home equity loan offers some fantastic advantages over many types of financing. Here are 10 things you should know about home equity loans before applying.

1. You’re signing up for a mortgage

Home equity loans are mortgages backed by real estate. They can also be called second mortgages if you take out a home equity loan while you’re still paying off your mortgage. That means your home is collateral for the loan. 

Laws governing mortgage lenders require special disclosures and a lot of consumer protections. That’s a good thing. If you borrow against the home where you live, for instance, you get three days after closing on your home equity loan to cancel it. That also means you have to wait three days after closing to get your money. 

2. You usually can’t borrow against all of your home equity

Home equity equals your property value minus what you owe on your home. If your home is worth $200,000 and your mortgage balance is $100,000, you have $100,000 in home equity. 

Many lenders cap home equity loans such that your total home debt (your primary mortgage plus the home equity loan you want) isn’t more than about 80% of your home’s value. In this case, you still owe $100,000, which is 50% of the value. If the lender’s limit is 80%, you might qualify to borrow another $60,000 with a home equity loan. That would bring your total mortgage debt to $160,000, which is 80% of the home’s value. Estimate your home value and look up your current mortgage balance before contacting lenders to see how much you could borrow. 

3. You’ll need a home appraisal

Lenders need to know what your home is worth before they can loan you money against it. They usually hire licensed home appraisers, who inspect your home and compare it to similar ones nearby. Then they make adjustments and come up with a value. 

Home appraisals cost a few hundred dollars and can take several days. However, you may not have to wait and pay for an in-person home appraisal. Some lenders allow a desk appraisal. That means they use home valuation software and public home sales records, rather than an in-person look at your home, to estimate a value. That could save you time and money. 

4. You’ll have to prove your income

It’s possible to get approved for many credit cards and some loans without proving your income. But because home equity loans are mortgages, the law requires lenders to verify that you can afford the loan. This is called the Ability to Repay (ATR) Rule. (Slightly different laws apply to home equity lines of credit.) 

Be prepared to submit pay stubs when you apply for a home equity loan. The lender might also want W-2s for wage earners or tax returns if you’re self-employed or have complicated income sources. 

5. Repayment terms are longer than many loans

Depending on the lender, home equity loan terms range from 5 years up to 30 years. When your loan amount is on the larger side (not unusual with home equity loans), longer terms could help you afford the payments more easily. 

However, taking longer to pay means your total interest cost will be higher. Choose the shortest term you can afford to keep costs down while you borrow what you need. 

6. Your interest rate will (probably) be fixed

Most home equity loans come with fixed interest rates. That means your interest rate and loan payment won’t change during the life of your loan. Payments that don’t change also make budgeting easier. 

The good thing is that your payment won’t increase if rates go up. On the other hand, fixed rates don’t drop when interest rates fall. 

7. You’ll (usually) receive a lump sum

When you borrow with a home equity loan, you usually get the entire loan amount when you close, and then you can’t borrow more. That means you could use home equity loans for big-ticket purchases, a down payment on another home, debt consolidation, large medical bills, home construction costs, or any large expense that requires a lump sum up front. 

Lines of credit are often better for smaller purchases, college tuition, home renovations that take place in stages, emergency funds for a business, or any other use when you don’t know the upfront costs or you’ll pay them over time. 

Achieve offers a fixed-rate home equity line of credit that comes with a five-year draw period. During that time, you can borrow, repay, and borrow more as often as you like, up to your limit.

8. You may be able to deduct your interest at tax time

Home mortgage interest is tax-deductible under certain conditions. (Always check with a tax advisor before borrowing if this is important to you.) Note that home loan interest is only deductible on up to $750,000 of borrowing for all mortgages against your primary home and/or vacation property.

With a home equity loan, the IRS says you can deduct the interest only if you use the proceeds to purchase, build, or “substantially improve” your home (from 2018 to 2025). Note that after 2025, you may be able to deduct home equity loan interest no matter how you use the money. 

9. On average, home equity loan interest rates are lower than other loan types

Home equity loans, like all mortgages, are secured by real estate. And most lenders consider real estate very safe and valuable collateral because it can’t be hidden or driven away like a vehicle, and its value tends to increase over time. 

That excellent collateral allows lenders to charge lower interest rates for home equity loans compared to other types of financing like credit cards. 

10. Home equity loans could help you improve your credit score

Home equity loans could help you raise your credit score in three ways:

• Every on-time payment helps your payment history, which is the most influential factor affecting your credit score. 

• If you use a home equity loan to consolidate credit card debt, you could improve your credit utilization ratio (your total credit card balances divided by your total credit limit). Utilization is the second most influential factor in credit scoring.

• If you currently only have credit cards, adding a mortgage could improve your credit mix. Having a diverse variety of credit accounts on your credit report could have a positive effect on your score.  

Note that any payment made within 30 days of its due date counts as on time for credit reporting purposes. Even if you miss your grace period and get hit with a late fee. 

How could a home equity loan help you reach your financial goals? Talk to a mortgage advisor about your options.