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Home equity loans can be helpful when a homeowner needs to make home improvements, but they can also assist with other expenses like consolidating debt or paying college tuition. Taking out a loan is no small decision, and it’s crucial to know the ins and outs of all available options. This guide will break down all the necessary information and outline some of the best home equity loans available.
What to Consider When Choosing One of the Best Home Equity Loans
When shopping for one of the best home equity loans, consider significant factors like the loan amount, loan term, and interest rate. Borrowers will also want to note the minimum credit score requirements, fees, options for preapproval, and loan closing.
Preapproval means that borrowers can ascertain how much they’re eligible to borrow from a lender before any money exchanges hands. A borrower will want to find out how much they can qualify for when shopping for a home equity loan to make sure they get the funds they actually need. Once a borrower has been preapproved, they will have a better idea of the interest rates they can expect on the loan. Preapproval typically requires proof of employment, income, and a Social Security number for a credit check. The lender’s credit report request will be listed as a hard inquiry, resulting in a dip in the borrower’s credit score. Fortunately, this dip usually bounces back quickly.
To obtain a home equity loan, a borrower must complete an application and submit supporting documents. This application requires personal information, including a Social Security number; proof of income and employment; and other financial records, including pay stubs, bank statements, tax returns, and mortgage paperwork. The stronger a borrower’s economic foundation, the better the interest rate.
HELOC vs. Home Equity Loan
Although both home equity loans and a home equity line of credit (HELOC) rely on how much equity a homeowner has in their home, they are not the same financial product. A home equity loan has a fixed interest rate, loan amount, and loan term. A borrower makes monthly payments on it like they would with their mortgage. Most lenders limit the loan amount to 80 percent of the home’s equity, although other factors also will affect the actual loan amount.
A HELOC is a type of home equity loan that works more like a credit card. A borrower is approved for a maximum amount of credit, which they can borrow against whenever they need to. The borrower repays the HELOC by making payments on the amount borrowed, not the total amount of credit. In addition, unlike a home equity loan, a HELOC typically features variable interest rates, which can affect how much the payments are.
Credit Score and Alternative Credit Data
Lenders look at a borrower’s credit score as the first gauge of how responsible they are with repaying debt. Lenders often require a minimum credit score to receive a home equity loan approval. Credit scores also can affect the interest rate a borrower receives on a home equity loan. In most cases, the better a borrower’s credit score, the better the interest rate they receive. A history of late payments, bankruptcy, or foreclosure on a borrower’s credit report can be a red flag to lenders.
Another factor lenders will review as part of a home equity loan application is the debt-to-income (DTI) ratio. A borrower’s DTI is determined by adding up all their monthly debts and dividing that number by their gross monthly income. Lenders use this number to assess a borrower’s ability to repay a home equity loan.
Most lenders want to see a DTI of no more than 43 percent; if a borrower’s DTI is higher, they may be viewed as potentially having trouble repaying the debt. A lender may make an exception if a borrower’s DTI is higher, but it’s best if a borrower can work to pay down their debt to decrease their DTI before applying for a home equity loan.
Loan Amount and Down Payment
A home equity loan amount depends on how much equity a homeowner has. Most lenders will not offer a home equity loan for more than 80 percent of a home’s equity. While this is a critical factor in determining a borrower’s loan amount, the lender also will review the borrower’s income, their home’s market value, credit score, and credit history. Unlike a home mortgage loan, a borrower won’t need a down payment with a home equity loan. Instead, the home equity is collateral for the loan.
The annual percentage rate (APR) is the amount of interest a borrower will pay over the home equity loan term. It is determined using points and financing charges. Fees on the loan may be listed as points or interest rate add-ons that increase the APR. These fees could include application, origination, processing, underwriting, appraisal, recording, broker, and lender fees.
When talking with a lender regarding a home equity loan, a borrower shouldn’t hesitate to negotiate to have these fees, points, or interest rates reduced or even eliminated. A borrower can also take their business elsewhere if another lender offers better loan terms.
Loan Term and Repayment Terms
For most home equity loans, the repayment period, or loan term, can range between 5 and 30 years. A borrower will pay fixed monthly payments for the life of the loan until it is paid in full. It’s essential to check the loan agreement terms to see if the lender charges a prepayment penalty should a borrower decide to pay off the home equity loan early. If it does, the borrower needs to compare the penalty amount to the amount of interest they would save by paying off the loan early to see which option provides the most savings.
Closing and Fees
Once a borrower has provided all the necessary information and paperwork for the home equity loan application, the lender will process the loan. Depending on the lender, this could take anywhere between 2 and 6 weeks. A borrower also may incur closing costs and fees based on the loan processing, such as appraisal or recording fees. It’s important for a borrower to review these closing costs and expenses before signing the loan papers. In addition, a borrower should carefully read and review all the loan documents at the closing before signing to make sure all the terms are what the borrower and lender agreed upon.
Our Top Picks
To help you find the best home equity loans, we have researched and compiled home equity loan terms and information from several lenders for your review.
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Why It Made the Cut: Discover has a relatively low APR range, fast closing time frame, limited fees, and high loan-to-value ratio, meaning borrowers can borrow closer to their home’s value.
Discover offers a lot to like for borrowers applying for a home equity loan. While its minimum credit score requirement of 620 is on par with other lenders, it has a much higher loan-to-value ratio—90 percent instead of a standard 80 percent—so a homeowner can borrow an amount much closer to their home’s value. The only drawback is Discover caps home equity loan amounts at $300,000, which is less than other lenders. However, it does have a quick preapproval and 2-week closing time frame, so a borrower won’t have to wait long to get the money they need. Discover’s APR range is reasonable for a home equity loan, and there are no application, origination, or appraisal fees. Combined, these features make Discover a top choice for home equity loans.
- Loan term: 10 to 30 years
- Loan amount: $35,000 to $300,000
- Preapproval time frame: 1 week
- Minimum credit score: 620
- Closing time frame: 2 weeks
- APR: 3.99% to 11.99%
- Relatively high loan-to-value ratio at 90 percent
- No application, origination, or appraisal fees
- Closing time frame is relatively short at 2 weeks
- Relatively low borrowing cap of $300,000
Best for Good Credit
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Why It Made the Cut: U.S. Bank offers more flexible borrowing limits than many other lenders, which could make it easier for borrowers to get the loan amount they need.
Unlike other lenders, U.S. Bank offers a broader range of loan amounts, starting at $15,000 and topping out at $750,000. It also won’t charge any closing costs. U.S. Bank also publishes up-to-date rates so borrowers can get an idea of what they might have to pay on a home equity loan. However, those rates usually apply to borrowers with above-average credit scores, and U.S. Bank also has a higher minimum credit score than other lenders. If a borrower meets these qualifications, U.S. Bank is definitely a choice to consider.
- Loan term: Up to 30 years
- Loan amount: $15,000 to $750,000
- Preapproval time frame: 1 week
- Minimum credit score: 660
- Closing time frame: Not specified
- APR: Starting at 3.8%
- Rates are published, up-to-date, and accessible
- Flexible borrowing limits between $15,000 and $750,000
- No closing costs
- Rates may not be as favorable for borrowers with average or below-average credit scores
Bank of America
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Why It Made the Cut: For borrowers interested in a HELOC, Bank of America offers flexible borrowing limits and has many branches nationwide if they want to meet with a loan officer in person.
While Bank of America does not offer home equity loans, it does offer a home equity line of credit, which can be a good alternative to a home equity loan for many homeowners. At Bank of America, a homeowner can borrow against the HELOC for 10 years, making payments on what they borrow. After the draw period ends, they will have 20 years to repay the HELOC balance.
Bank of America’s HELOC offers a higher maximum limit ($1 million) than most home equity loans at other lenders. It also considers alternative credit data, not just an applicant’s credit score. Unfortunately, Bank of America’s preapproval time is longer than other banks because approval comes in the form of a physical letter through the mail. If a HELOC is a better choice than a home equity loan, though, a homeowner can’t go wrong with Bank of America.
- Loan term: 10-year draw, 20-year repayment
- Loan amount: $25,000 to $1 million
- Preapproval time frame: 10 days
- Minimum credit score: 620
- Closing time frame: 30 to 45 days
- APR: 1.99% for 6 months, then starting at 4.4%
- Alternative credit data may be considered at the time of application
- Loan amounts up to $1 million available
- Relatively long preapproval time
- Only HELOCs are available
Discover earned Best Overall because borrowers can quickly qualify for a home equity loan with few fees. U.S. Bank is great for those with a good credit score and history, earning a borrower some of the lowest interest rates available on a home equity loan. Bank of America delivers flexible loan amounts for borrowers interested in a HELOC.
How We Chose the Best Home Equity Loans
To determine which lenders offer the best home equity loans, we reviewed a number of factors for home equity loans, including minimum and maximum loan amounts, loan terms, interest rates, prequalification and closing times, minimum credit score requirements, loan-to-value ratios, and closing costs and fees. We also looked for lenders that serve borrowers nationwide and noted whether or not they had brick-and-mortar locations for borrowers who prefer to speak with a loan officer in person. We also looked for lenders with a reputation for having strong financial standing to serve their clients.
Before You Choose One of the Best Home Equity Loans
When shopping for one of the best home equity loans, a borrower needs to shop around to find the best loan terms for their financial situation. Not every home equity loan lender will be the right choice. Check with at least three different lenders and carefully compare their loan terms to ensure they are equitable regarding loan amounts, loan length, interest rates, closing costs and fees, and minimum credit score requirements.
As a borrower talks with lenders, they should give each one the same information so the lenders can evaluate a borrower’s financial situation on the same basis. Try to get loan offers on the same day for the best comparison; interest rates change frequently, so loan offers even just a few days apart could be vastly different due to the interest rates.
Cost of Choosing One of the Best Home Equity Loans
As a borrower shops around for a home equity loan, they should carefully review how much they will pay in fees and closing costs. Some lenders have minimal or no fees, but not all. A borrower will also need to review interest rates to see which lender offers the lowest rate. And, in some cases, a borrower may not find a reasonable interest rate with any lender offering the best home equity loans; they might find that they could receive a better interest rate on a credit card or personal loan. Therefore, it’s important to consider all financial options before getting a home equity loan.
The Advantages of Using One of the Best Home Equity Loans
Using one of the best home equity loans to pay for large expenses could be the best financial tool a borrower has available. With a home equity loan, a borrower could receive a lower rate than with other financial tools such as a personal loan or credit card. In addition, because the existing home equity secures a home equity loan, it could be easier to qualify for the home equity loan than other loans. And with a home equity loan, a borrower may get a longer loan term for repayment, making it easier to pay off the loan as agreed. Some additional benefits include:
- Fixed interest rates for the life of the loan (does not apply to HELOCs)
- Possible tax-deductible interest
- Lump-sum cash payment is received when a homeowner takes up the loan
- Relatively simple borrowing process
With the many considerations of a home equity loan, shopping for a home equity loan can be confusing. A borrower must research and learn what a home equity loan is and how it works to understand the loan terms before signing on the dotted line.
Q. How do you qualify for a home equity loan?
To qualify for a home equity loan, a borrower needs to meet the lender’s requirements for income, minimum credit score, and home equity amount.
Q. Is a home equity loan the same as a mortgage?
Although not exactly the same as a primary mortgage, a home equity loan does work as a second mortgage but may have a shorter loan term.
Q. How long does a home equity loan last?
For most home equity loans, the repayment period, or loan term, can range between 5 and 30 years.
Q. Does a bank do an appraisal for a home equity loan?
Yes, a bank likely will do an appraisal for a home equity loan to determine the home’s current market value.
Q. What percentage of equity can I borrow?
Most lenders limit a borrower’s loan amount to 80 percent of the home’s equity, although other factors also will affect the actual loan amount.
Q. Are there penalties for paying off a home equity loan early?
Some lenders charge prepayment penalties if a borrower pays off the home equity loan early, so review the loan terms to see if a prepayment penalty applies to the loan.