If you’ve been paying your mortgage for a while, you’ve probably built up some equity in your home. Home values statewide have increased 27% in the past 5 years according to data from multiple listing services. You may have heard of a home equity line of credit or loan, but you might not understand why it would be an option for you. One great thing about home equity is that you can use it to finance life events, like your children’s college tuition or upcoming wedding.
What is Equity in a House?
The definition of home equity is the difference between how much your home is currently worth (or its market value) and how much you still owe on your mortgage. Here’s a quick example to help you figure out how much lendable equity you have:
- Your Current Home Value: $250,000
- 80% of Current Home Value: $200,000
- Minus Your Current Mortgage Balance: $160,000
- Equals Your Home Equity Balance: $40,000
Using Your Home Equity for Life Events
Mortgage lenders allow you to borrow against your home’s equity, using your home as collateral, which is why they are sometimes referred to as second mortgages. The general guideline is that you can borrow up to about 80% of your home’s value.
Although many people like to apply for a home equity loan or line of credit to finance home improvements, you can also leverage your home’s equity to finance a variety of things including:
- Debt consolidation
- Weddings
- College
- Repairs and Improvements
- Other life events
How Does a Home Equity Line of Credit Work?
With a home equity line of credit, or HELOC, you can take out money as you need it during the draw period, which is determined by the lender. This is similar to a credit card, in that once you pay off what you’ve borrowed, you can borrow more. For example, if you take out a $10,000 home equity line of credit and pay $3,500 toward the principal, you’ll have $6,500 in available credit. HELOCs interest rates are variable and your payments are based on how much credit you’ve used, as well as the current interest rate. The interest rate on home equity lines and loans is typically lower than unsecured consumer financing such as credit cards or personal loans.
What is a Home Equity Loan?
A home equity loan allows you to take out a lump sum of money, similar to a personal loan. Like a home equity line of credit, your home equity loan will be determined based on the value of your home and your mortgage balance. With a home equity loan, your interest rate is typically fixed, and your repayment amount is the same each month. In contrast to a HELOC, you can’t keep taking out money once you’ve paid back the principal.
How to Get a Home Equity Loan or Line of Credit
To qualify for a home equity loan, lenders will look at your debt-to-income ratio, or DTI, based on your gross income to figure out how much of your income is already promised to other lenders. This factor helps lenders determine if you’re a good fit for this type of loan. Typically, the lower your DTI, the greater chance you have to qualify for a home equity loan or line of credit. Lenders look for your DTI to be under 36%; however, Fannie Mae and Freddie Mac typically allow up to 45% DTI. If you aren’t there yet, try to pay down your debt or reduce your other monthly expenses.
Mortgage lenders like C&N Bank in PA and NY will consider your loan-to-value ratio, or LTV, too. This is the amount you still owe on your mortgage divided by your home’s current market value. To make sure your home’s value is accurate, you’ll need an appraisal. Typically, the lower the ratio, the better your chances of qualifying. Typically, LTV ratios need to be 80% or below to qualify for a home equity line of credit. Lenders need to keep a cushion of about 20% equity in the home for the protection of the homeowner and lender, because over any given period it is possible for home values to decline.
Building up equity in your home is like money in the bank for a rainy day. If you need extra money to pay for your children’s education, make home improvements, or pay for unforeseen expenses, tapping into your home equity could be a good option. Talk to our local mortgage representatives in PA or NY to get started.
