How much of your home do you actually own?
Depending on how much of a down payment you made when you bought your home and how much of your mortgage you’ve paid off, the amount of house that’s truly “yours” will vary.
Both those factors, along with how much the house might have increased in value between when you bought and today, contribute to how much equity exists in your property.
Equity represents your stake in your home. And your home is an asset, but an illiquid one — meaning, the value is held in that equity and it’s not always easy to use or quickly exchange for cash.
That doesn’t mean it’s impossible.
A home equity loan is one way to tap into your home’s value and use it today. You can use that equity to pay for expenses or make home improvements. However, there is a cost. And first, you need to get approved. Here’s what you need to know.
What Is a Home Equity Loan (and Is It Right for You)?
Your home value, minus what you still owe on your mortgage, represents how much equity you have. A lender can originate a loan for you using that equity as collateral against the loan.
You receive the funds as a lump sum of cash and can use them however you’d like — but you also need to make monthly payments to repay that borrowed money in the time frame specified in the terms of your home equity loan.
Those monthly payments will include interest, which is what the lender charges for allowing you to borrow that money all at once. And you absolutely need to repay everything you owe, because remember: your home equity is the collateral.
That means you could lose your ownership in your home if you default on the loan. It’s important to borrow no more than you truly need and can reasonably afford to repay, and it helps to have a plan for how you’ll repay that money ahead of time.
But once you understand what these loans are and how they work, you can decide if you’d like to use one yourself. If so, you can take the steps below to get approved for a home equity loan.
Step 1: Know How Much Equity You Can Use, and How Much You Need
You need to start by understanding how much equity you have available. Lenders will require verification before they’ll originate a home equity loan for you, but you should still know these numbers ahead of time.
Doing so allows you to plan. You need to know not only how much equity you have, but also how much of that you truly need to tap into. Remember, borrowing costs money in the form of interest and the more you borrow the more interest you’ll pay.
To estimate how much equity is in your home, you can use a site like Zillow or Redfin to get an idea of how much your home is worth. From there, you can simply subtract the amount you would need to completely pay off any loans associated with your home.
If your home is valued at $500,000 and you owe $375,000 on the mortgage, you can estimate that you have about $125,000 worth of equity you could potentially tap with a home equity loan.
Step 2: Check Your Credit Score
Lenders will want to know your credit score before they approve you for a loan. But just like your equity, you may want to check on this before you apply so you can be more informed.
Find out your credit score for free at sites like Credit Karma or Credit Sesame. These sites give you an estimation of your score, but you can also try to get your official FICO score that lenders use. Many credit cards now offer FICO scores on monthly statements as a cardholder perk, and some banks and credit unions will occasionally provide your score without a fee. Ask to see if your bank can provide it for you.
Most lenders want to see a credit score of 620 or higher before they’ll approve you for a home equity loan. If you do have bad credit, you may want to try to improve your score before applying. Having good credit can help you secure better terms or interest rates.
That being said, know that there is some flexibility here because home equity loans are secured loans. Your home is being used as collateral, which is less risky to a lender than an unsecured loan (or a loan made without collateral).
You may find a home equity loan easier to qualify for with poorer credit — but you’ll still pay a premium for the financing through a higher interest rate. It’s worth it to take some time to try and raise your score before seeking approval.
Step 3: Consider the Impact of Your Other Balances and Debts
Your debt-to-income ratio, or DTI represents how much money you owe on outstanding debts and balances versus how much you earn each month. Lenders calculate DTI by adding up all of your monthly debt payments and dividing those by your monthly income,
(If you want some help calculating your DTI, this calculator can do the math for you.)
Most lenders won’t approve you for new loans or financing if your DTI is above about 43 percent. Even if your DTI is under that range now, lenders may not approve you if a new home equity loan would push your ratio above 43 percent.
There may be some exceptions and you could find a lender who will underwrite your loan — but even if you do, proceed with caution. Having half your income dedicated to debt repayment is a tough financial spot to be in and could lead to financial trouble if you’re not careful.
If you you find your number on the high side, consider taking the time to create a debt repayment plan and lowering your existing balances first — or look for alternatives to leveraging your home equity without taking out a loan.
Step 4: Prepare for an Appraisal
As part of the review process, most lenders require an appraisal of your home to confirm the home’s value (and therefore, the amount of equity available to you).
Lenders use appraisals to determine a loan-to-value (LTV) ratio, or the current mortgage balance divided by the appraised value. You can estimate yours here with this calculator.
Once you add in the amount you wish to borrow, this becomes the combined LTV. Most lenders want to see a loan-to-value ratio at about 80 percent or less, but it can vary depending on the lender and your credit score.
If your LTV is too high, you can start to bring it down by paying more than the minimum on your monthly mortgage principal. For a shorter-term fix, however, consider how you can make a few smart changes now that can impact the results of your appraisal.
Keep your home clean, organized, and tidy, and take care of any repairs you’ve been putting on the backburner before an appraiser comes for an inspection. Know what areas make a big impact, like caring for your yard and keeping the exterior in good condition.
You don’t need to go and get a whole new roof, but do consider the little things you can do immediately and for little investment. That could make a difference in the appraised value of your home.
Step 5: Start Gathering Quotes and Apply
Once you’ve taken care of the above to-dos, you can start looking for lenders. Before applying, request quotes so you can compare terms and interest rates across various options.
Don’t forget about lenders that cater to those in certain professions, like teaching or public services roles, as well as military members. These niche lenders can provide great rates and service to their borrowers.
Make sure to gather these quotes in a 14-day time period, too. Doing so will ensure that any hard pulls on your credit report will be counted as “rate shopping,” which will protect your credit score.
Gathering quotes over a long time period means each pull shows up, which can drop your score by about 5 points every time.
Remember to ask about fees or closing costs that the lender may charge, and if they are due up-front or rolled into the loan amount. This fees can add up, and significantly add to the cost of your loan. Consider these and the interest rates before making a final decision.
Once you know the lender you’d like to go with, the final step is to apply and get approved for a home equity loan that can help you leverage your cash flow and achieve your financial goals.
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