Home equity loans help homeowners finance home improvements, repairs, college expenses or various other outlays, using the equity (value) in their home as collateral. Home equity loans are more commonly known as a second mortgage. However, before you jump into the home equity loan pool and commit to that second mortgage payment, it’s essential to know what you need to have beforehand, as well as what you need to do in order to qualify.
Step 1: Check your credit
Before applying for any loan or credit card, you should always check your credit first.
Each year, you are eligible for a free copy of your credit report (from all three bureaus) by visiting the annual credit report website.
If your credit score is upwards of 620 and you do not have any late payments within the last two years or any delinquent accounts in collection, you are a strong candidate for a home equity loan. If not, you have some work to do in order to improve your score.
If you unsure of where to start, talk with a licensed mortgage broker about qualifying guidelines and things you can do to give your credit score a boost.
Step 2: Take a preliminary look at equity
Most lenders will not grant a home equity loan unless you have at least percent equity in your home.
To find out how much equity you have, look up the most recent county tax assessed value of your property. Visit your local county tax assessor’s office either online or in person to get this figure. The tax-assessed value of your home enables you to figure out how much equity you have.
Subtract your mortgage balance from your tax-assessed value, and you have an estimate of your home’s equity.
For example:
Tax assessed value: $177,000
Mortgage balance: $72,000
Using the example above, deduct the mortgage balance from the value of the home. In this example, this person has $105,000 in home equity – more than the minimum 20 percent.
If you have more than 20 percent equity, you can move forward. If not, you might not be a candidate for a home equity loan and should talk to a loan officer about your options.
Step 3: Check your savings
Closing on a home equity loan is not free. Closing costs will typically be between two and five percent of the total loan amount.
In addition to closing costs, there are appraisal fees required by the lender. The appraisal verifies your home’s value and is the most important determining factor regarding how much equity your lender thinks you have, and how much they will lend to you. The cost for bank appraisals will range anywhere from $300 to $500 in most areas.
Using the example above, closing costs on $105,000 worth of equity range between $2,100 and $5,250.
If you have adequate savings, you can move forward with the loan process.
Step 4: Shop rates
Shop home equity loan terms and rates with different lenders until you find one you are happy with in the same way you would compare terms and rates when shopping for a first mortgage.
Hint: Getting a home equity loan from your current mortgage company is usually a smart move, and most first mortgage lenders will offer competitive rates for a second mortgage.
Step 5: Apply
To apply for a home equity loan, you will need your last three months of paycheck stubs, last 12 months of bank statements, last two years of tax returns and an estimate of your debt (anything you pay on each month, excluding your home). Most lender applications can be started online. Once all of the paperwork is verified and approved by the lender, home equity loans are closed and funded within 30 to 45 days.
Make smart choices when looking into a home equity loan by being prepared for the process in advance, having all of your paperwork together and knowing your options long before you head to the closing table.