A home equity loan, sometimes called a second mortgage, is a type of loan that lets you borrow against the equity on your home. Unlike home equity lines of credit, which give you access to revolving credit, this type of loan gives you a pre-established amount and is paid out as a lump sum. These loans also feature fixed interest rates and require monthly payments over a period of five to 30 years.
Since home equity loans are paid out upfront, they are useful for large one-time expenses. In addition, home equity loans can be tax deductible if used for home repairs or renovations. However, as with any other secured loan, they are also risky — since you’re offering your stake in your home as collateral, the bank could foreclose on the home if you were to default.
Read on for a step-by-step guide on how to get a home equity loan and some factors to consider before applying for one.
How to get a home equity loan
The requirements to qualify for a home equity loan are similar across most banks and credit unions. Generally, lenders will ask for enough equity, a good credit score and a low debt-to-income ratio.
Before you start the application process, it’s important to consider the following factors:
1. Determine how much equity is in your home
Home equity refers to how much you’ve already paid for your home, as opposed to what you still owe the mortgage lender.
The first step in determining how much equity you have is by getting your home professionally appraised. You then subtract your current mortgage’s outstanding balance (what you still owe the bank) from your home’s appraised market value — the amount the home could sell for.
Lenders usually require that borrowers have at least 15% to 20% of equity in their home to qualify for a home equity loan. They will also consider your loan-to-value ratio (LTV), which is used to assess the risk of the loan.
Banks prefer a lower LTV ratio, since it indicates that you have more equity than loan debt. (To calculate your LTV ratio, divide your remaining loan balance by the appraised value of your home.)
This requirement means that borrowers who are underwater on their mortgage — meaning they owe more than the home is currently worth and so are considered to have negative equity in the home — will not be approved for a home equity loan. It’s also not a likely option for most brand new homeowners who have not yet built enough equity in their homes.
2. Check your credit score
Most home equity loan lenders prefer borrowers with FICO scores of 700 or more; however, some do have more lenient requirements and accept borrowers with scores as low as 620. As with any other loan, the higher your credit score the greater your chances of approval and the lower the interest rates you’ll be offered.
Borrowers with fair to poor credit scores will find it difficult to qualify for a home equity loan, although it’s not completely impossible. Some lenders do cater to borrowers with poor credit but will charge much higher interest rates. (Check out how to get a home equity loan with bad credit for more detailed actionable steps.)
If your FICO score is below 620, we recommend you wait and work on reducing your overall debt load and improving your score first. You might also want to request your credit reports from all three bureaus — Experian, TransUnion and Equifax — and check for any mistakes that might be dragging your score down. If you do find mistakes, you could consider a credit repair service, which can help dispute any outdated or incorrect information listed in your report.
3. Calculate your debt-to-income ratio
The debt-to-income ratio (DTI) is another common metric that lenders use to determine your ability to repay a loan. This ratio reflects how much of your monthly income goes toward paying existing debts and lets banks know whether you can afford to take on new debt.
It’s calculated by dividing your total monthly debts by your monthly gross income. For instance, if you earn $6,000 a month and your debts (this includes recurring debts such as mortgage, auto loan, student loan and credit cards) total $2,500, your debt-to-income ratio would be 42%.
Lenders usually prefer a DTI ratio of 43% or less, although a select few may accept higher ratios of up to 50%. Overall, having a lower DTI ratio may improve your approval chances and help you get better interest rates.
If you have a high DTI ratio, consider paying down outstanding debts and avoid taking on new ones.
4. Compare rates and fees
As with any loan, it pays to shop around for rates and fees.
Aside from looking for lower rates, ask lenders about any loan-related fees, such as application fees, origination fees, closing costs, annual fees and cancellation or early payment fees.
Some banks don’t charge loan fees and are more likely to waive closing costs if you don’t pay off the loan before a specified date.
If you’re still considering your options, we recommend checking our reviews for the best home equity loans.
5. Apply
Applying for a home equity loan is not a decision you should take lightly, after all your house could be at risk if for some reason you default. Before applying, make sure you can take on an additional debt.
This being said, most lenders will require proof of a stable income to make sure you’ll be able to repay the loan. They may also ask for the following information and documents:
- Social Security number
- Driver’s license or government-issued photo identification
- Utility bills to confirm current address
- Current mortgage billing statement
- Property tax bill
- Recent paystubs
- Two year W-2 forms
- Tax fillings
- Co-applicants documentation (if applies)
How long does it take to get a home equity loan
While some lenders offer same-day approvals, this is something that can vary widely depending on the lender’s requirements and complexity of the application process. In most cases, it can take anywhere from one to two weeks, and up to a month, to fully complete the process and receive the funds.
To get a better idea of how long the process can take, you should ask the lender for more information about their particular timelines.
What can affect the quickness of lenders’ decision
Some factors that can impact lenders’ timelines, include:
- Missing documents: Lenders ask for a variety of documents to support your application, such as recent income statements, proof of employment, property tax bills, tax returns and copy of homeowner’s insurance. Not having the necessary documentation readily available may impact how quickly the bank can process your application.
- Verification: After receiving your documentation, lenders review them and ensure the information is correct. If more information is needed, they may request more documents, which could delay the process.
- Home appraisal: Lenders will typically request a full property evaluation from a certified appraiser to determine your home’s value. This process can often take several days, and impact the application process. You may ask the bank whether you can request an evaluation in advance or use one you already have.
- Underwriting: Once your application and documentation is submitted, an underwriter will assess your financial information and determine whether you’re eligible for a home equity loan. This process can take a few days, sometimes weeks, depending on your application and the lender’s workload.