Your chances of getting a home equity loan depend on two key things: your combined loan-to-value (CLTV) and credit score. Before seeking a home equity loan, it helps if you are looking good on each of these fronts. However, having a less-than-impressive credit score and CLTV doesn’t mean you can’t get a home equity loan.
First off, you need to understand what a home equity loan is. In a home equity loan, your home’s equity acts as the collateral. Home equity value is based on the current value of your home, less outstanding mortgage balances on the property.
Below is a beginner’s guide on how to get a home equity loan for your family:
1. Estimate your current home equity
In order to get a home equity loan, your first step is to review your financial situation as it currently stands. Lenders will evaluate both your creditworthiness and financial health. It helps first to do this review yourself to establish what your chances are of getting such a loan.
Ideally, to qualify for a home equity loan, you should have a 620 credit score or higher. Besides, your credit reports should demonstrate a clear history of responsible credit. Other requirements include verifiable income sources and/or stable employment history. Lastly, to get a home equity loan, you must have equity in the first place. This is the value you get after deducting your mortgage balances from the current home value.
As the collateral for the equity loan, your home could be in jeopardy should you fail to pay the mortgage. Smart borrowers first evaluate their financial situation before proceeding with the home equity loan application.
2. Use tools to calculate home equity
As noted above, a home equity loan hinges on whether you have home equity. This is the balance you get after subtracting your mortgage balances from the value of the home.
A competent valuation company can help you establish the appropriate value of your home. Other online tools, such as Eppraisal or Zillow, could help you to get a home equity loan.
3. Decide how much you need to borrow
Just because you have impressive home equity doesn’t mean you should borrow as much as you can. Like with other loans, always borrow what you need based on your ability to repay. This will help you determine the most appropriate home equity loan size. Don’t be driven by how much home equity you can borrow, but by how much you need.
In establishing your ability to borrow, your combined loan-to-value (CLTV) and credit score are carefully examined. To calculate your CLTV, the new home equity amount is added to your current mortgage balance and divided by the value of your home. Depending on your credit score, you can borrow up to a certain percentage of your CLTV.
4. Consider your ability to repay the loan
As mentioned, any loan, let alone a home equity loan, is contingent upon one’s ability to repay it. The personal review you conducted of your financial situation should give you a good idea of the amount you can afford to borrow.
However, beyond how much home equity loan you can afford, establish how much in terms of monthly payments you can comfortably afford. Use online calculators to estimate your monthly payments and make a budget to pay off the home equity loan.
5. Shop for the best home equity loans
While you should start your hunt for a home equity loan at your current bank or credit union, you should spread your search much further. Look up several lenders to establish which one has the most competitive interest rates and fees.
You can also gather bids online. However, be careful about overly sweetened offers that are usually too good to be true.
6. Determine the type of home equity loan needed
There are two types of home equity loans you can get: the regular home equity loan and HELOC (home equity line of credit). You must understand the implication of each of these flavours to determine the one that’s best suited for you.
A standard home equity facility gives you a specific loan amount that you repay, usually at a fixed rate, for a fixed duration. A HELOC facility works more or less like a credit card. It allows you to borrow up to a certain amount. With a HELOC loan, you enjoy interest-only loans at adjustable rates within a specified time. This is called the draw. HELOC loans revert to a fixed-rate upon the commencement of repaying the principal.
7. Get clarification on interest rates & fees
Once you determine the type of home equity loan you need, get as much information as possible concerning applicable interest rates, fees and closing costs. Go through the fine print with a fine-tooth comb before you proceed with your application.
There’s a critical document called the Good Faith Estimate that every lender is mandated to provide three days after you receive your loan application. Go through this document keenly before completing the form.
8. Choose a loan rate structure
Lastly, after doing your due diligence, you now have to choose between a fixed and a variable interest rate home equity loan. Variable interest rates are adjustable and are subject to prevailing market dynamics.
On the other hand, fixed interest home equity loans are for the risk-averse, although they tend to be more punitive to homeowners in the long run.