There are plenty of times in life when you may need cash at the ready but don’t know the best source to get it. For example, you might want to consolidate debt and take several high-interest payments into one low-interest payment.
A home equity loan is a popular method to take advantage of the equity in your home and turn it into the cash you need, but it’s not your only option. We’ll go over what a home equity loan is and some popular alternatives if you’re looking for a home equity loan alternative.
What Is A Home Equity Loan?
A home equity loan is a type of second mortgage that uses the equity in your home as collateral for a one-time, lump sum payment. Once you receive the money, you pay it back like you pay your original mortgage. You have monthly payments based on a fixed interest rate over a set number of years. This payment will be in addition to your existing monthly mortgage payments.
However, there are many alternatives to home equity loans that may be a better option for you.
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Why Consider Home Equity Loan Alternatives?
Home equity loans are an excellent resource for big purchases that pay off in the long run. You can use them for your child’s college education or home improvements to increase your home’s value. They can also be a valuable tool to consolidate debt from multiple sources with high interest rates. But they’re not always suitable for every person or purchase.
Home equity loans are paid in one lump sum, so if you need long-term financing for an unknown amount, it can be hard to predict how much to borrow. Home equity loans also come with the same risk as your original mortgage. Most critically your home is collateral so it’s important to make timely monthly payments. Keep in mind you usually need more than 15% – 20% equity in your home to apply for a home equity loan. Equity loan amounts are based on max loan to value for a home including other mortgages.
Alternatives To Home Equity Loans
If you don’t know exactly how much money you need, don’t have enough equity in your home or don’t want another mortgage payment, check out the alternatives to home equity loans below.
1. Home Equity Line Of Credit (HELOC)
A home equity line of credit (HELOC) is a type of second mortgage that functions differently from a home equity loan. With a HELOC, you can draw from a line of revolving credit instead of receiving a lump sum of money. Like a credit card, you can take out an amount of money up to your credit limit and make monthly payments toward whatever you take out.
With a HELOC, you can take out cash only when you need it. You will have monthly minimum payments during the first part of your loan, or draw period, to cover the interest of the loan. Eventually, you need to pay back the loan balance on the money you’ve borrowed.
Essential Pros And Cons Of A HELOC
Every loan option comes with benefits and disadvantages. Let’s take a look at the main ones for a HELOC.
Pros: The main advantage of a HELOC is the flexibility. This is why HELOCs may work better than home equity loans if you are paying for a long-term project. Especially if you don’t know the exact cost ahead of time.
Cons: The main downside to a HELOC is you pay adjustable interest rates versus the fixed rates of a home equity loan. You will also still be using your home collateral.
Lender Requirements For A HELOC
Since HELOCs are collateral loans, you’ll need to meet specific lender’s requirements to get a HELOC. To qualify for the loan you’ll generally need to meet the following criteria:
- An updated appraisal of your home’s value
- At least 15% – 20% equity in your home, though more is likely needed
- A 620 credit score or higher
- A debt-to-income (DTI) ratio of around 43% or less