Unlocking home equity: How do home equity loans work?

Do you know how much equity you have in your home? An advantage to being a homeowner is harnessing the equity you've built up when you need cash. You may need to fund home improvements or want to consolidate your debt. Whatever the reason for leveraging your equity, home equity loans are an attractive solution for most homeowners.

Point Editorial Team
March 23, 2022
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What is a home equity loan?

Home equity loans  — also called second mortgages and equity loans  — allow homeowners to borrow money against the equity in their homes. They hold a fixed interest rate and can have a repayment term of one to thirty years. Home equity loans can offer a competitive rate compared to other consumer loans. However, other home equity loan alternatives may offer the best rate depending on the market.

How do home equity loans work?

At a glance, a home equity loan works similarly to most other loans ⁠— a borrower takes a lump sum of money and repays it in fixed installments over a set period. Lenders will set the fixed interest rate, loan amount, and repayment terms — and the borrower chooses to agree.

The amount you can borrow will vary based on how much of your home's equity you own, which is determined by the current market value and the remaining balance of your mortgage. Generally, borrowers can take up to 85% of their home's worth. For example, a house worth $500,000 would be eligible for a maximum loan of $425,000. However, there might be additional restrictions on how much you can borrow based on a credit check and your debt-to-income ratio (DTI). 

Unlike other loans, home equity loans often have associated closing costs. The costs vary based on the lender but commonly range from 2% to 5%. Again, depending on the lender, you can potentially roll closing costs into your monthly payments. 

The pros and cons of home equity loans

In addition to confidently answering “how do home equity loans work,” it's essential to understand the advantages, disadvantages, and true cost of borrowing

  • Lower rates:  They offer competitive rates compared to other alternatives — interest rates range from 2.5% to 9.99%, depending on the length of your repayment terms.
  • Fixed interest rate: There's a set interest rate over the life of the loan — this exempts borrowers from the volatile housing market.
  •  No restriction on funds: You have access to the total amount of the loan immediately and are free to use the funds however you choose. 
  • Long repayment terms: The repayment term can be as long as 30 years.
  • Monthly payments: Taking on additional expenses can greatly reduce your monthly cash flow.
  • Closing costs: Unlike other consumer loans, you'll be charged 2% to 5% in closing fees. 
  • Owing more than it's worth: Home equity loans are determined based on the value of your home during the market conditions in which you apply. Consequently, if your property value drops significantly, you could owe more than your home is worth. 
  • Foreclosure risk: If you fall behind on payments, you may need to sell your home to repay the loan. In severe cases, you could lose your home.

What are the requirements for securing a home equity loan?

The requirements for a home equity loan vary from lender to lender. However, there are specific criteria that every lender will assess:

  • Equity: To qualify, you should own at least 16% of the equity in your home — holding more will allow you to secure more funding.
  • Credit check: A minimum credit score of 680 is favorable for most lenders. Similar to other loans, a higher score will give you a better rate.  
  • DTI: A debt-to-income ratio of 43% is necessary to qualify for a home equity loan. DTI is calculated by dividing your total monthly bill payments by your gross monthly income.
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Home equity loan FAQs 

What is the current rate for a home equity loan?

Recent inflation has significantly impacted home equity loan rates. The current national average is 7.74%. 

How can I build home equity? 

Every mortgage payment entitles you to more equity in your home. By maintaining regular payments  ⁠— or increasing them if possible — you'll continue to grow your equity. Additionally, equity will increase as the value of your home rises. Simple home renovations are one way to boost home value. 

Can I secure a home equity loan with no credit check?

The simple answer is no. Credit checks are an essential part of the application process, allowing lenders to evaluate the risk level of potential applicants. 

What can I do if I have bad credit?

Although securing a home equity loan with no credit check is impossible, working with a poor credit score is doable. However, it does make it more challenging to secure the loan. Most lenders require a minimum credit score of 680, though some will go as low as 620.

If you're applying with a lower credit score, gather as much financial information as possible to share with potential lenders — such as income and investments. It's likely your application may require a cosigner. Working with a trusted person with a strong credit score and stable income may position you to be approved.

Home equity loan alternatives

Several home equity loan alternatives exist, each with various qualifications and terms that may be more appealing based on your needs.

Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is an excellent option for borrowers interested in access to small funds when needed. Like a credit card, a HELOC offers a revolving line of credit in which you pay interest only on what you use.

For example, if you were approved for a HELOC of $100,000 but only took out $20,000, you would only have to pay interest on the $20,000. However, if you were to take out an additional $20,000 from that same HELOC, you would pay interest on the total $40,000 borrowed. 

Cash-out refinance

A cash-out refinance replaces your existing mortgage with a larger one, giving you the difference between the two in cash. Since you sign a new contract for the mortgage, your mortgage rate will likely change. Therefore, this option makes sense if you can secure a lower interest rate compared to what you have. 

The current average rate for a 30-year fixed refinance is 6.78%, and the average for a 15-year fixed-rate refinance is 6.07%. 

Home Equity Investment (HEI)

Another competitive home equity loan alternative is a Home Equity Investment (HEI). You can receive a lump sum of cash with no restrictions and no monthly payment in exchange for a portion of your home's future appreciation. Instead, you repay the amount plus a percentage of your home's appreciation through a home sale, refinance, or another source of funds at any time during the 30-year term. 

See if you qualify for a Point HEI today.

Final Thoughts

While home equity loans with no credit check aren’t available, various home equity loan alternatives can provide different requirements or terms that may better suit your needs. Deciding which option is best for you and your unique situation can be difficult. Your decision may be based on various factors — including the amount you wish to receive, the time frame you have to repay it, and the overall cost you are willing to pay. You’ll also need to weigh the advantages and risks associated with each to determine your best path.

Only you can decide if a home equity investment or HEI from Point is the right choice for you. Schedule a call with a home equity specialist today to learn more.

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