What is a Home Equity Loan or Line of Credit?

Help me understand home equity loans and lines

If you own your home, you’ve likely heard about the concept of building equity, and with it a herd of questions: what is equity? How does equity work? How does it benefit me? Our article will sort through some of the information around home equity loans and home equity lines of credit to help you understand them and whether they are a good solution for you.

Understanding equity and how to calculate equity

In the most basic sense, equity is the amount of your home that you actually own. In other words, it is the current value of your home minus the amount you still owe on your home. Keep in mind that the current value of your home may be different – either less or more – than what you originally paid for it.

To estimate the current value of your home, websites like Zillow or Trulia provide current market information. These values are estimates, though, and while helpful in estimating the current value of your home, a home appraisal will be required to accurately assess your home’s value.

Once you have an understanding of how much your home is worth, you need to know exactly how much you owe on your home. It’s then simply a matter of subtracting how much you owe from your home’s value.

Understanding home equity

The infographic below helps explain equity as well as how equity can be used.
 

Qualifying for a Home Equity Loan or Home Equity Line of Credit (HELOC)

One of the first questions you may ask after understanding equity is, “Do I qualify for a Home Equity product?” Qualifying for a Home Equity product will depend on several factors, not the least of which is your financial institution’s lending policy. What will be fairly consistent across the board, though, is good credit and an acceptable debt-to-income ratio.

Your credit score is going to be an important factor in any lending decision. It is essentially a mathematical calculation of the likelihood you’ll be able to repay your loan. Several factors impact your credit score, including late payments, length of your credit history and how much of your available credit you’ve used. It’s critical to not only know your score but to be aware of what’s actually in your credit report, too.
 

Watch our brief video to help you understand your credit

Debt-to-income (DTI) measures how much you pay in debt against how much income you make. Generally speaking, the lower your DTI the better. A higher DTI may indicate to your financial institution that you are stretched too financially thin and won’t be able to make payments on your Home Equity product. Even if you have good credit, a high DTI can impact your eligibility for a Home Equity Loan or HELOC.

The difference between a Home Equity Loan and a Home Equity Line of Credit and the benefits over other loans

When looking at home equity products, you will typically see both Home Equity Loans and Home Equity Lines of Credit. There are definite advantages to both of these products, so let’s break down how they differ and the benefits of home equity.

A Home Equity Loan is similar to a Personal Loan in that it carries a definitive term (how long your payoff period is) and a fixed interest rate. You receive the amount you are approved for as a lump sum. The total amount you can borrow is determined by your financial institution’s loan-to-value (LTV) policy as well as the value of your home.

A Home Equity Line of Credit (HELOC), on the other hand, provides you with an amount against which you can borrow as much or as little as you need. The interest rate on HELOCs is often variable, but is only charged when you draw against the balance. The amount of your HELOC is determined just as the amount of a Home Equity Loan would be. Your financial institution’s LTV policy and your home’s value will determine the amount you could be approved for. Once you are approved, you can borrow against the line as often as you need.

Watch our brief video to understand equity and the difference between Home Equity Loans and HELOCs

The benefit of a Home Equity Loan or a HELOC comes from the fact that these products are secured by your home’s equity. Because of this, these products will typically carry a lower interest rate than an unsecured Personal Loan. Lower interest rates can save you hundreds, even thousands, of dollars.

In addition, the fact these products are secured allows you to borrow more money than you usually can with a Personal Loan, making big-ticket purchases possible. This makes Home Equity Loans and Home Equity Lines of Credit appealing when you need funds for things like home renovations or tuition costs.

Find out more about Home Equity Loans and Home Equity Lines of Credit.