Despite recent interest rate hikes, home values are still rising, with national median listing prices up 14.2% in April 2022 compared to the previous year. If your home’s value continues to climb, does the amount that you can borrow on a home equity loan continue to increase as well?
- As your home’s value rises, the amount of equity you can borrow against with a home equity loan increases proportionally.
- If you can’t pay your home equity loan back, you could lose your home in a foreclosure.
- If you tap too much home equity and your home’s value decreases, you could go underwater on your loans and be unable to sell your home without a significant financial loss.
- Even if you have a lot of equity, you’ll still have to qualify for a loan with decent credit and income.
How a Home Equity Loan Works
A home equity loan is a loan that allows you to borrow a set amount of money against the equity you have in your home. Home equity loans typically offer low or no fees and allow you to pay back your loan with a fixed interest rate and equal monthly payments over a set period of time.
By contrast, a home equity line of credit (HELOC) also allows you to tap your home’s equity but functions more like a credit card, allowing you to use as much or as little of your credit line as you need and pay back variable amounts each month with a variable interest rate.
Existing Home Equity Loans
If you already have a home equity loan and want to tap more of your home equity after your home’s value has increased, you’ll have to take out another home equity loan. If you’re considering this, contact your existing lender to see if you can consolidate a new home equity loan into your existing one.
How Home Equity Is Calculated
Your home’s equity is calculated by taking the current market value of your home and subtracting any loans that you currently have on it. The number that remains is the amount of equity you have in your home. To get your equity percentage, you would divide the amount of equity you have in your home by the current market value of your home.
Calculating Your Home’s Market Value
It can be tempting to use the estimated value of your home from Zillow or Redfin, but these estimates aren’t always accurate. Unless you recently had an appraisal done, you’ll likely need to pay for a separate appraisal to be completed to get a home equity loan. Online estimates are a great starting point, but calculate your home equity yourself so you know a ballpark figure of what you’ll qualify for. Do a little bit of extra research into recent home sales in your neighborhood, and be sure to adjust for the current condition of your own home. Since home values are changing quickly in current market conditions, be sure to check back on your numbers monthly so you don’t get a big shock after you’ve paid for an appraisal.
Dangers of a Home Equity Loan
Home equity loans have several pros and cons that should be weighed, in addition to considering their risks, before taking one out. Since home equity loans use the equity in your home as collateral, you could lose your home if you can’t keep up with payments. In general, you should only take out a home equity loan to fund a project that will increase your home’s value.
What happens to my home equity loan if my home’s value decreases?
Nothing special will happen to your home equity loan itself if your home’s value decreases. More concerning is what happens to your ability to sell if the value of your home dips below the total balance on your mortgage and home equity loan(s). In this situation, you are considered underwater on your loans and would have to pay money to your lender(s) upon selling your home.
Should I wait for the value to rise before taking a home equity loan?
Nobody can accurately predict the future value of your home. There is no guarantee that your home value will increase. If you need to take out a home equity loan to pay for a needed improvement to your home, and if you currently have enough equity for the project, then now is the best time to take out a home equity loan.
How much equity do I need for a home equity loan?
Individual lender requirements will vary. Most lenders require a combined loan-to-value (CLTV) ratio of 85% or less, but some lenders publicize their acceptance of up to 90%.
The Bottom Line
Home equity loans are based on the amount of equity you have in your home. If your home’s value rises, the amount of equity you have in it rises, and the amount that you can take out for a home equity loan increases proportionally.