Home Equity 101: Everything You Should Know

Published on January 4, 2022 under First-Time Home Buyers

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Investing in real estate is a complicated procedure that involves various statistics, computations, and permissions. While most homeowners are familiar with the notion of equity, they may not fully know what it is, how to create it, or what types of equity loans are available.

Here is everything you should know about home equity:

What is a Home Equity Loan?

Home equity is defined as the difference between what you owe on your mortgage and what your home is valued at. A home equity loan allows you to borrow against the value of your home's equity, which is the percentage of its value that you own outright after any current mortgages or equity loan obligations have been paid off. The greatest amount of equity you may obtain varies by lender, but most financial institutions limit it to 85% to 90% of the total value of your house, including all debts.

Requirements for a Home Equity Loan

Home equity loan criteria are the same regardless of the sort of loan you pick. The requirements differ depending on the lender, but in general, you'll require:

  • At least 15% equity in your home: the difference between the mortgage debt and the home's market value is referred to as equity. This figure is used to calculate the loan-to-value ratio, or LTV, which determines your home equity loan eligibility. Doing home upgrades and paying your mortgage fees, on the other hand, can help you build equity in your property.
  • A credit score of 600 or higher: The exact credit score criteria vary by lender, but to qualify for a home equity loan, you'll need a score in the mid-to-high 600s. A high score (say, 700 or higher) usually means a simple qualification process and accessibility to the best rates.
  • Debt to income ratio of 43% or slightly below: The debt-to-income ratio, or how much of your monthly salary your loans consume, will also be taken into account. Lenders usually want a DTI of 43% or less. Divide your monthly costs (mortgage, student loan, normal bills, child support, and other debt) by your monthly income to determine your DTI.

When considering taking a home loan, you should look for specific pros and cons.

Benefits of a Home Equity Loan

If you take out home equity loans, you may discover you have some advantages over other types of borrowing. Some pros are as follows:

  • Lower interest rates: home equity loans feature lower interest rates than unsecured loans like personal loans or credit cards since your home serves as collateral.
  • Longer payment terms: home equity loans are repaid over a 20-year period. This, along with lower interest rates than unsecured loans, might result in a relatively low monthly repayment.
  • Fixed interest: unlike a home equity line of credit (HELOC), which has a variable rate that can change at any time, a home equity loan has a fixed interest rate.
  • Interest may be tax deductible: another advantage of home equity loans is that they may qualify for a tax deduction. If you use the money to significantly enhance the property used to secure the loan, you may be able to lower the interest paid on the loan by up to $100,000.

Cons of Home Equity Loans

  • Risk: your home serves as collateral. If you default on your loan, your lender has the power to repossess your home in the worst-case situation. Damage to other parties is also possible - repossession leaves a permanent stain on your real estate agent's company name.
  • You will have two mortgage repayments: if you're still paying off your first mortgage, your monthly housing payments will lower your disposable income, detracting from your savings and other financial goals.
  • You'll pay closing costs: closing costs for home loans typically vary from 2% to 5% of the total loan amount. These can be incorporated into a loan, but they should be taken into account while weighing your alternatives.

If you're looking to buy or refinance a home, you may consider partnering with First Savings Mortgage for a personalized, advanced and intuitive mortgage loan. For more information, please contact us today.

Please note, by refinancing your existing loan, your total finance charges may be higher over the life of the loan.

Contact an Expert Loan Officer