Home equity loans have become a common way to pay for big-ticket expenses like home improvements, college tuition, and debt consolidation. If you’re considering tapping the equity that you’ve accumulated in your home, here’s what you need to know about shopping for a home equity loan.
- Home equity loans can be relatively easy to obtain if you have sufficient equity in your home and meet other requirements.
- The main downside of a home equity loan is that your home will be at risk if you can’t keep up with the payments.
- Before you shop for a loan, decide how much you need to borrow and how long you want to take to pay it back.
- To compare the cost of home equity loans from different lenders, find out each loan’s annual percentage rate (APR).
Before You Go Shopping for a Home Equity Loan
You can simplify your search for a home equity loan if you make some key decisions beforehand.
1. Decide if a home equity loan is your best option
Like any kind of borrowing, home equity loans have their pros and cons. On the plus side, if you have enough equity in your home, a reliable income, and a strong credit score, they may be relatively easy to obtain. They also may offer relatively low interest rates compared with certain other kinds of loans. On the minus side, they are secured by your home, and—if you can’t repay the loan for one reason or another—you could find yourself out in the street.
Before you commit to a home equity loan, be sure to consider the alternatives, especially if you have any concerns about your ability to repay. For example, you might qualify for an unsecured personal loan from a bank or a credit union. It could have a higher interest rate, but you won’t be putting your home at risk. You also may be able to obtain a personal loan more quickly.
If you’re looking to borrow money for college, federal student loans should be at the top of your shopping list. These loans are unsecured, have relatively low interest rates, and offer a variety of flexible repayment plans.
And while a home equity loan can be an economical way to consolidate and pay down high-interest credit card debt, you’ll be trading unsecured debt for debt that’s secured by your home. Another option, if you qualify, would be to transfer your card debt to a new credit card with an attractive balance transfer offer, such as 0% interest for six to 18 months—and then pay it off as aggressively as possible.
Still another way to draw on the equity in your home is through a cash-out refinance. In a cash-out refinance, you take out a new mortgage that’s large enough to pay off your old mortgage plus provide you with some additional cash to use as you please. However, be sure to compare the interest rates on the old and new loans before committing. In a time of rising interest rates (such as mid-2022), you probably don’t want to give up a low interest rate mortgage to take on more debt at a higher rate.
You’ll generally need a FICO score of at least 680 to qualify for a home equity loan, according to Experian, one of the three major credit bureaus.
2. Decide how large a loan you need
If you’ve determined that a home equity loan is your best option, the next question is how much you want to borrow. Again, because you’ll be putting your home at risk, it’s best to borrow no more than you really need, even if the lender is willing to offer you more.
Lenders set limits on how large a loan they’ll issue you, based on the equity you have in your home, your income, and your creditworthiness. They generally may cap their loans at about 80% of your equity. Most lenders also set minimum amounts for their home equity loans, often $10,000 or higher.
Because your creditworthiness will also figure into the equation, it’s worth checking your credit reports for accuracy before you apply for a loan. You can obtain free copies from each of the three major credit bureaus at AnnualCreditReport.com, the official website for that purpose. If you find any errors that put you in a bad light, such as unpaid bills that you know you paid or accounts that you don’t even recognize, challenge them with the credit bureau.
Note that your credit score is not part of your credit report. You can obtain it for free from some credit card companies and on reputable credit monitoring websites.
If you aren’t sure how much money you need to borrow—say you’re embarking on a multistage home improvement project—you might want to consider a home equity line of credit (HELOC) rather than a home equity loan. It allows you to borrow up to a certain limit over a period of time, and you aren’t obligated to borrow the entire amount. However, HELOCs generally have variable interest rates, so if rates rise, then your borrowing costs will as well.
3. Decide on the repayment term you want
Lenders offer a variety of repayment terms for home equity loans. You can get one that you’ll pay off over five years, 10 years, 15 years, or longer. The shorter the repayment period, the higher the monthly payments. But a shorter repayment period will usually mean a lower interest rate as well as a lower total interest cost over the life of the loan.
When You Go Shopping for a Home Equity Loan
Once you have some idea of the kind of home equity loan you want, you’re ready to shop for one. You can get a home equity loan from a bank, a credit union, or an online lender. A good place to start might be a financial institution where you already do business. But don’t stop there.
You’ll be safest going with a lender whose name you recognize. Be especially wary of any unsolicited offers for home equity loans that come to you via mail, email, or phone.
To compare the cost of home equity loans of the same term length, ask about their annual percentage rates (APRs). The APR should incorporate not only the loan’s interest rate but also any additional costs, such as points and fees. Note that the lender may have some flexibility in these charges, so don’t hesitate to try to negotiate a better rate.
To get a quote from a lender, you’ll need to supply some basic information on:
- Your home, including its purchase price and current estimated value
- Your estimated income from work and other sources, such as investments
- Any other debts, such as credit cards and your current mortgage, if you have one
If you decide to go ahead and submit an application, you’ll need to provide additional information and documentation to verify all of the above, as well as proof that you’ve paid your property taxes and have the appropriate insurance on your home. For example, the lender is likely to request copies of your pay stubs, W-2 forms and 1099-DIV statements, tax returns, bank statements, and more.
During the application process, the lender will most likely assign a professional appraiser to assess your home’s current market value.
Once your loan is approved, you’ll receive the money you’ve requested in the form of a lump sum. How long that will take can vary from one lender to another and according to how simple or complex your financial situation is. Lenders typically estimate the waiting period at anywhere from two weeks to a month or more. If you’re in a hurry for the money, it’s worth asking before you apply.
Is home equity loan interest tax deductible?
That depends on what you use the money for. Since the passage of the Tax Cuts and Jobs Act of 2017, the interest on home equity loans and home equity lines of credit (HELOCs) is deductible only if they are used “to buy, build or substantially improve the taxpayer’s home that secures the loan,” the Internal Revenue Service says. The rules may change in the future, however, as that provision of the law expires in 2026.
Can you refinance a home equity loan?
Yes, you can refinance a home equity loan. You might consider refinancing if you either can get a lower interest rate or want to extend your repayment period. However, check whether your current home equity loan imposes a prepayment penalty if you pay it off before the end of its term.
Can you get out of a home equity loan if you change your mind?
Yes, but you have to be quick about it. If you sign up for a home equity loan but change your mind, you usually have three business days to cancel without penalty. Saturdays count as business days, but Sundays don’t.
The Bottom Line
A home equity loan can be a convenient source of cash to cover major expenses. However, you may have better alternatives. To shop for a home equity loan, compare the APRs on loans of the same term length and ask about any prepayment penalties in case you want to pay the money back early.