How Does a Home Equity Loan Work?

For many homeowners, their house is their most valuable asset. That can prove especially useful when you have significant expenses come up, like home improvements, debt consolidation, college costs, or emergency expenses. You can utilize your leverage in your home to take out a loan, usually at lower interest rates than other options like personal loans or credit cards.

Home equity refers to the amount of your home that you’ve paid off, which is your stake in the property. Each month as you make your mortgage payment, you’re paying down the principal on your mortgage, thereby increasing your home equity. This is important because that increased stake in your home can allow you to borrow new funds against that equity you’ve built up.

Understanding what home equity is, how you can use it, and the types of home equity loans available are important pieces of knowledge for every homeowner, and we explain them all below.

What is Home Equity?

Home equity is the current, appraised value of your home minus any outstanding loan balances, including your mortgage.

For example, if your home is worth $250,000 and you owe $100,000 on your mortgage, your home equity is $150,000. That’s also the amount you would be able to borrow against with a home equity loan.

Like we alluded to earlier, the great part of this equation is that the amount you owe on your loan will decrease every month as you make payments and reduce your principal balance.

How Do I Build Home Equity?

The easiest and most straightforward way to build up your home equity is by making your monthly mortgage payments. But there are other ways to increase it:

• Make a large down payment. The more money you’re able to put down on your home, the less you’ll need to finance. This will help you start your mortgage off with a higher equity stake.
• Pay more than your minimum mortgage payment. If your loan allows you to pay more than your monthly payment and applies that to your principal, you can start building equity even faster.
• Renovate to increase your home’s value. There are several ways you can improve your home’s curb appeal, such as renovations, additions, and even landscaping. Interior improvements, like new cabinets or updated flooring, will add value too.

How Do I Use My Home Equity?

After you’ve built up enough equity, you can put it to use by taking out a home equity loan. In doing so, you’re taking out a new loan against that ownership stake you’ve already established. You will need to meet some qualifications before being able to take advantage of a home equity loan, and this is the baseline for most lenders:

• Home equity of at least 15-20%.
• Credit score of 620 or higher.
• Debt-to-income ratio of 43% or lower.

What Are My Options for Home Equity Loans?

There are three popular types of home equity loans for you to choose from:

Home Equity Loan

This is essentially a second mortgage.

• Once the loan closes, you get paid one lump sum.
• You pay it back with monthly installments, with interest.

Home Equity Line of Credit (HELOC)

This option is a revolving credit line, operating like a credit card, with the limit being determined by your home equity.

• There is a draw period in which you withdraw funds from the lender up to the amount you’re approved for.
• This is followed by a repayment period, where you make monthly payments with interest.

Cash-Out Refinance

This method involves refinancing your mortgage. Your new mortgage will include the original amount you borrowed plus the new amount you’ll receive in cash, hence the name.

• This results in one new mortgage payment, encompassing both your original mortgage amount and the new cash you borrowed.

There are several factors to consider when making decisions that impact your home finances. If you’re considering a home equity loan, we encourage you to connect with an experienced Loan Officer who will work with you to gain a thorough understanding of your personal situation and make a recommendation for the best loan products tailored to your needs.