Types of home equity loans: a guide

Homeownership comes with a lot of perks – one of these perks is your equity. Your equity can help you finance major purchases, pay for costly renovations, and even eliminate debt and plan for retirement. 

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When you want to access the equity in your home – whatever the reason – you have a multitude of options available. Let’s go over the possibilities and cover the different types of home equity loans. 

Home equity: An overview

Defined simply, home equity is the portion of your home that you own free and clear of any debt tied to your home. Your home equity grows over time as you make your monthly mortgage payments – and as your home appreciates.  

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To calculate how much equity you have in your home, simply subtract your mortgage and any other obligations secured by your home from the total value of your home. For example, if your home is worth $500,000, and you owe $300,000 on your mortgage, you have $200,000 of home equity. 

Types of equity loans

There are more financial solutions tied to your home equity on the market today than ever before. We’ll go through the most popular products and explain their differences – and their similarities. 

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Each of these types of equity loans is secured by your home, meaning that the lender puts a lien on your home – and your home could be at risk if you don’t meet the terms of your contract. While that may sound scary, it also generally results in favorable rates compared to any unsecured product. 

Home equity loan

The most straightforward product on the list, a home equity loan is easy to understand for any homeowner with a mortgage. In fact, people sometimes refer to this financial tool as a second mortgage. 

How it works

This loan comes in a lump sum, with a predictable, fixed-rate monthly payment. The term can range anywhere from 5 to 30 years.

Requirements

• Credit score – 680 is a common threshold for lenders, although some may go as low as 630. 
• DTI/income - You’ll need a DTI (debt-to-income ratio) of under 43% and a steady, documented income to qualify. 
• Home equity – You’ll most likely need to own at least 15% equity in your home, although 20% is more common. 
• Other – Not all lenders will work with investment properties, so a home equity loan can be more challenging to find unless you’re looking to borrow against your primary home. 

Considerations

If you’re a fan of the predictability of fixed-rate loans, this is one of your best options. However, you will pay a slight premium for the security of that loan. 

HELOC

In contrast to fixed-rate home equity loans, a HELOC generally comes with a variable rate – and that’s just where the differences begin. HELOCs and home equity loans are both secured by your home, but how they behave in practice is very different.  

How it works

Home Equity Lines of Credit (HELOCs) are revolving credit lines tied to your home – similar to credit cards. 

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The life of a HELOC is broken into two segments, the draw period (most often 10 years) and the repayment period (most often 20 years). 

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During the draw period, you can take out funds from your line of credit, all the way up to your maximum draw amount. You are required to make interest-only payments – but do not have to pay anything toward the principal balance. Just as with your credit card balances, when you pay down the line of credit, you can take the funds out again. 

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During the repayment period, you cannot take out any additional funds, and your payment switches to both principal and interest. 

Requirements

HELOCs have almost the same requirements as home equity loans. 

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• Credit score – 680 is a common threshold for lenders, although some may go as low as 630. 
• DTI/income - You’ll need a DTI (debt-to-income ratio) of under 43% and a steady, documented income to qualify. 
• Home equity – You’ll most likely need to own at least 15% equity in your home, although 20% is more common. 
• Other – Just as with a home equity loan, not all lenders will work with investment properties. 

Considerations

Your HELOC will generally come with lower closing costs, but there are some fees involved. Depending on your HELOC lender, you may have to pay an annual fee for every year your HELOC is open. Some institutions also charge draw fees, or have minimum draw amounts. Make sure to be fully aware of all the costs that come with a specific HELOC before moving forward. 

Additionally, make sure to plan for the moment when your payment switches over from interest-only to interest and principal. This can be a shock to some people’s budget. 

Cash-out refinance

If you have a mortgage, you already know what to expect with a cash-out refinance. Unlike a home equity loan, which is a separate entity from your mortgage, a cash-out refinance replaces your first mortgage with a larger amount – and you pocket the proceeds. 

How it works

With a cash-out refinance, you pay off your existing mortgage with a new, larger mortgage and pocket the difference. Just as with a regular mortgage, your cash-out refinance can come with a range of terms and conditions. 

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A cash-out refinance can have a fixed interest rate or a variable one, and the term can last anywhere from 5 to 30 years, although a 30-year mortgage is always the most popular. 

Requirements

• Credit score – 580 is the absolute minimum here, but many lenders will not go below 620. 
• DTI/income - You’ll need a DTI (debt-to-income ratio) of under 50% and an income high enough to cover your new, more expensive mortgage. Some lenders will not go higher than 43%. 
• Home equity – You’ll most likely need to own at least 15% equity in your home, although some lenders will go as high as 95%. 

Considerations

Because you are replacing your existing mortgage with a new one, you need to consider the difference between your interest rate and the interest rates available on the market today. If your existing mortgage is 3%, and you refinance at 7%, the cost over the life of your loan will be astronomical. 

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Closing costs also tend to be higher for a cash-out refinance – not because the percentage is higher, but because the loan amount is larger. 

HEI

A Home Equity Investment (HEI) is different from a traditional loan, but this financial product can be a worthy alternative for homeowners looking into different types of home equity loans. This financial tool is a particularly good fit for homeowners with unconventional financial situations, or those looking to avoid a large monthly payment. 

How it works

You get a lump sum in exchange for a share of your home’s future appreciation. There are no monthly payments, instead, you repay your HEI with a balloon payment at any time before the end of your term, typically 10 or 30 years, depending on the HEI provider. Homeowners most often repay the HEI when they sell or refinance their home. 

Requirements

• Credit score – 500+
• DTI/income - No DTI/income requirements 
• Home equity – You’ll need to own a large amount of equity, though this varies by HEI company 
• Other – Because this is a newer financial product, you’ll need to have a home in a location where HEIs are available. While investment properties are welcome, manufactured homes and farms on acreage are generally not eligible. 

Considerations

Because an HEI is tied to your home’s value at the time of repayment rather than a traditional interest rate, you will not be able to know exactly how much you owe until it’s time to pay back. It’s very important to have an exit plan and know how you will repay your HEI when the time comes. 

Reverse mortgage

This solution, built for seniors who want to stay in their homes but still benefit from their home equity nest egg during retirement, is only available for homeowners aged 62 or older. 

How it works

You get cash in either a lump sum, a monthly payment, a line of credit – or even sometimes a mix of the above. The term lasts for as long as at least one owner on title lives in the home for most of the year. The balance accrues interest over time, and comes due when the homeowner stops living in the property. 

Requirements

• Credit score – Some reverse mortgage lenders have no credit score requirements. 
• DTI/income - No DTI/income requirements 
• Home equity – You’ll need to own at least 50% equity in your home. 
• Other – Only homeowners age 62+ are eligible. The older you are, the more of your equity you are eligible to borrow. 

Considerations

You’ll need to pay off your first mortgage, if you still have one, with the proceeds of your reverse mortgage. Additionally, reverse mortgages come due when the homeowner on title passes away, which can make it challenging to pass on the property. 

Taking equity out of your home: an overview 

All types of equity loans have a few things in common: 

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• The loan (or financial instrument) is backed by your home, meaning that you could lose your home if you fail to make your payments. 
• Your home will likely need to be appraised (or otherwise valued) as part of the application process. 
• You’ll go through an underwriting process, similar to when you first bought your home. 
• These loans will generally take a bit longer than an unsecured loan, like a personal loan, due to the underwriting and valuation process. 

FAQs

What is the difference between a HELOC and a home equity loan?

A HELOC is a line of credit while a home equity loan is a loan that is more similar to a second mortgage. HELOCs tend to have a variable interest rate while home equity loans have a fixed interest rate. 

What is the cheapest way to get equity out of your house?

The cheapest way to get equity out of your house will vary depending on the borrower and their unique financial situation, including credit score, DTI, and other variables.   

What type of loan is an equity loan?

An equity loan is a secured loan, backed by a piece of collateral – typically the borrower’s home. 

Final thoughts

There are more types of equity loans available to homeowners today than ever before. If you would like to unlock your home equity with no monthly payments, and no need for income requirements or perfect credit, see if you qualify for a Home Equity Investment from Point today. 

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