Home equity loans are available in more places than you might think. This article explains where to find home equity loans, how they work, and how to make sure you're getting a good one.
- You can get a home equity loan from a credit union, bank, or specialized lender.
- A good home equity loan should have no or low fees, a low fixed interest rate, no prepayment penalties, and transparent terms.
- The best way to compare the costs of different loans is by checking their annual percentage rate (APR).
- Be sure to verify that any lender you're considering is legitimate and licensed to do business in your state.
How Home Equity Loans Work
A home equity loan allows you to borrow against the equity you have accumulated in your home. You receive a single lump-sum payment that you then pay back over time in equal monthly installments, typically at a fixed interest rate.
Where You Can Get a Home Equity Loan
Home equity loans are available from many of the same lenders that issue regular mortgages. If you belong to a credit union, it will most likely offer a home equity loan option with highly competitive rates and fees. In addition to credit unions, many banks offer low- or no-fee home equity loans. There are also lenders that specialize in home equity loans.
When you have a few candidates in mind, be sure to get estimates from each lender so you can do some comparison shopping. That includes the loans' fees, terms, and annual percentage rates (APRs). You should use the APR when comparing costs to get the most accurate comparison.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).
What to Look for in a Home Equity Loan
First, make sure that any lender you are considering is legitimate. The lender should be able to provide you with its Nationwide Multistate Licensing System (NMLS) number. You can use the number to look it up on the NMLS Consumer Access webpage to verify that it is properly registered to do business in your state and see if any complaints have been filed against it.
Once you've determined that you're dealing with legitimate lenders, here are the most important features to look for in their home equity loans.
- No prepayment penalty: Especially with higher interest rates, you'll want the option to pay off your home equity loan ahead of schedule without any fees or penalties for doing so. Paying off your home equity loan faster than simply making the minimum payment can save you thousands of dollars in interest. It will also free up your equity, making you less likely to become underwater if your home's value declines.
- Low or no fees: There are many home equity loan options with zero fees or extremely low ones. This can save you a large amount of money upfront when you take out the loan—or save you interest over the life of the loan if you roll the fees into the loan.
- A low interest rate: A lower interest rate will save you a significant amount of money over the life of the loan. As mentioned above, the rate you want to focus on is the APR, which takes into account both the basic interest rate and additional fees, giving you the best picture of what the loan will actually cost you.
- A fixed interest rate: While most home equity loans have a fixed interest rate, not all of them do. Make sure you're signing up for one with a fixed rate so you aren't surprised by an increased payment amount down the road.
- Transparency: All home equity loans should provide clear information before and at loan signing including the loan amount, APR, interest rate, fees, any prepayment penalties, and the loan term (length). All home equity loans must provide clear information under the TRID (TILA-RESPA Integrated Disclosures) rule.
What Are the Risks of a Home Equity Loan?
A home equity loan uses your home as collateral to give you a lower interest rate than you could get with unsecured debt like a credit card or a personal loan. As a result, you could lose your home if you can't keep up with the payments. Another big risk with a home equity loan occurs if you tap too much equity and your home's value then decreases. When this happens, you could become underwater on your loans, meaning that you owe more on your home than it is worth. That, in turn, could prevent you from selling the home until its value increases or you've paid down your loans sufficiently, which might take years.
What Are the Alternatives to a Home Equity Loan?
The best alternatives to a home equity loan could be a robust emergency fund or budgeting and saving in advance for future expenses that you would otherwise use a home equity loan for. When saving in advance isn't an option, a 0% APR credit card or a personal loan are both alternatives that don't risk your home if you can't afford to pay them back.
What Are the Requirements to Get a Home Equity Loan?
To be approved for a home equity loan you will need to have a good credit score, a low debt-to-income ratio, a verifiable income history showing you'll have sufficient income to pay back the loan, and a combined loan-to-value ratio of 90% or less.
The Bottom Line
A home equity loan can be an easy way to borrow money at a relatively low interest rate, but in the process, you are risking your home. When searching for a home equity loan, look for an option that will save you the most money and also give you the flexibility to pay off your loan early if you're able to.