What is a Home Equity Loan and How Does it Work?

If you are a homeowner, you may be sitting on tens of thousands of dollars in cash. In recent years, housing values across the nation have dramatically risen since the housing crisis in 2008. According to Zillow, the upward trend in home values began in early 2015. From 2017-2018, home values increased by 8.7 percent. Home values in 21 of the top 35 housing markets are higher than they were at the peak of the real estate boom in 2006. This is an excellent option if you need large sums of cash for anything, including launching a startup.

Gorgeous house with large lawn

If you were fortunate enough to purchase a home soon after the 2008 housing crash, you can have access to a large sum of money through a home equity loan. When you obtain a home equity loan, you are borrowing money from the equity you have in your home. For instance, if you have a home that is valued at $450,000 and your mortgage balance is $300,000, then you have $150,000 in equity. You will not be able to borrow the entire $150,000, but you will be able to borrow a significant portion of this amount.

Home Equity Loan Calculation

Obviously, if you do not have any equity in your home, then you cannot get a home equity loan. First, your loan-to-value ratio (LTV) must be 80 percent or less. For example, your $300,000 mortgage balance on your home that is valued at $450,000 has an LTV ratio of 66 percent ($300,000/$450,000 = .66)

When you apply for a home equity loan, your lender will use a simple calculation to determine how much money you can borrow from your home’s equity. Your lender will start with 80 percent of your home’s value, then subtract your mortgage balance to get your loan amount. The calculation looks like this: $450,000 x .80 = $360,000 – $300,000 = $60,000 loan amount

What Could You Do with $60,000?

Once approved, you will receive your money up front in one lump sum. At this point, you can use the money for any purpose. Most people who get a home equity loan use it for home renovations or to consolidate debt. Other uses include paying emergency expenses, paying educational expenses, putting a down payment on a second property, or going on a dream vacation.

Home Equity Loan Requirements

It is simple to get a home equity loan because your home is used as collateral. You should have at least 20 percent equity based on the appraised value of your home. You should also have a minimum credit score of 620 with no delinquent or derogatory marks on your credit report. Your debt-to-income ratio should not be higher than 50 percent. Requirements will vary, so check with your lender to make sure you meet their qualifications.

Beautiful houses on the river, perfect collateral for home equity loan.

Getting the Best Home Equity Loan

There are two things you can do to get the best loan. First, make sure you do not have any problems with your credit report. If you have any late payments or delinquent accounts, make sure you get caught up with your payments or pay off the accounts. Doing this will improve your credit score, which can help you to get better rates and terms on your loan. Second, shop around for a lender who will offer you the best rates and terms. Every lender is different and has different requirements. Make sure you find the lender that works best for you.

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