Applying for a home equity loan may take anywhere from a few days to a few weeks. After you submit an application, the lender will ask for paperwork from you, such as your current mortgage statement, property tax bill and proof of income. You’ll then need a home appraisal, which your lender may assist you with. When your lender approves your loan, you are eligible to borrow up to a predetermined amount, usually a percentage of your home’s value. This amount depends on how much your lender qualifies you for. In many cases, you can find out what amount you may prequalify for. Your lender will use the equity in your home as collateral, which is why these loans are often known as second mortgages. You can take out a home equity loan when you’ve paid off your mortgage or use it to refinance an existing one. You receive a lump sum for the loan amount and repay the loan with regular payments for an agreed amount of time.

Most home equity loans offer fixed interest rates, meaning that the interest rate stays the same even if market conditions change. If you don’t repay the loan as stated in the terms of your agreement, you risk defaulting on your loan, and your lender may foreclose on your home. How Much Equity Can You Borrow? Prior to the Great Recession in 2007 to 2009, financial institutions were more willing to approve home equity loans. Most lenders today are more cautious. The specific amount you’ll be approved for depends on your credit history, income and home’s market value. Lenders each have a certain set of criteria, one being the loan-to-value ratio, that they’ll use to determine your eligibility for a loan. According to the Federal Trade Commission, the maximum loan approval amount is usually 85 percent of your home’s value, factoring in your existing mortgage. For example, let’s say your home is currently valued at $200,000, and you still have $150,000 left on your existing mortgage.

If a lender approves 85 percent, that means you can borrow up to a total of $170,000, minus what you have left on your existing mortgage: $170,000 - $150,000 = $20,000. So you can borrow as much as $20,000. Benefits Homeowners most likely to benefit from a home equity loan are those who want to budget for exact monthly payments. Fixed payments: According to Dan Green, founder and CEO of Growella, a website that helps millennials learn about real estate, a home equity loan is best for those who want to ensure their payments don’t change. “If you plan to pay off the new loan in stretches of five years or longer, the stability can protect you long term, in case interest rates change,” he says. Since the payments do not change, you don’t risk paying higher interest rates even if the prime rate rises. Lower interest rates: Home equity loans usually have lower interest rates than credit cards and other types of unsecured debt. Because your home acts as collateral for the loan, lenders take on less risk and are more willing to offer lower interest rates. Tax deductions: Limited tax deductions are available for home equity loans, such as if you use the loan to complete capital improvements.

It’s best to consult a tax professional to figure out your exact situation. Drawbacks Home equity loans may not be a good fit for those who don’t want to tie up their equity for a five- to 30-year term or who want the option to take out money multiple times. As Green explains, “Other types of loans like a home equity line of credit allow you to borrow on your credit line multiple times, which is a helpful safety net when life goes sideways.” Your equity is lowered: It’s no longer equity when you use it to secure a loan. Your loan amount is subtracted from the home equity you’ve built. Risk of foreclosure: If you don’t make the payment schedule required by your lender, you risk defaulting on the loan. The lender can foreclose on your house. Potentially higher costs: Even with a lower interest rate, you may end up paying more if you take out a long-term home equity loan for a short-term expense. Immediate payment upon sale of home: Your loan needs to be repaid immediately if you sell your house.

If you used the money to make home improvements that increase your home’s value, you might be able to cover the payment. However, if your home’s value remained the same or decreased, you could find yourself with a large bill. Strict requirements: You will most likely need a good credit score in addition to solid proof of income and at least 20 percent of home equity to qualify for a loan. Ellie Mae, a software company that helps process U.S. mortgage applications, reported in August that 70 percent of people who closed loans had a credit score over 700. Alternatives to Home Equity Loans Even though a home equity loan is a great way to borrow money, it may not be the right fit for everyone. “A home equity loan may not make sense if you’re not planning on using the entire amount right away,” says Buddy Broome, an independent civil litigation attorney and real estate investor. “For example, if you want a consistent cash flow stream or don’t want to borrow a huge sum of money at once, you may want to look at other options.” Other types of home equity financing also use your home as collateral but work differently in terms of how you receive the loan amount. HELOC. A home equity line of credit, or HELOC, is a type of home equity loan that works like a credit card. You’re preapproved for a certain amount, and it acts like a revolving line of credit. You’re allowed to borrow as much as you need as long as you don’t go over your limit. Like a home equity loan, HELOCs use your home as collateral, and the interest you pay may be tax deductible. However, HELOC loans tend to have variable interest rates, which means that your rate can fluctuate for the duration of your loan. HELOCs also have a draw period where you may make interest-only payments during that time then an additional repayment period afterward. Cash-out refinancing. A cash-out refinance is refinancing an existing mortgage to get a larger loan amount. When you’re approved, your lender pays off your existing mortgage and gives you the difference from the refinance in cash. Your new loan may have different terms than the original one, meaning you may have a different payment schedule and monthly payments so that you pay off the mortgage by the new loan term. It is available either as an adjustable or fixed-rate loan. Reverse mortgage. Reverse mortgages are for homeowners 62 and older, and the homeowner receives monthly payments from the lender. Over time, the loan amount increases, and your home equity declines. The money you receive is typically tax-free, and you don’t have to pay back the loan as long as you reside on the property.

You or your estate pays the loan if you sell the house, move out or pass away. There are three kinds of reverse mortgages: federally insured reverse mortgages, called Home Equity Conversion Mortgages; proprietary reverse mortgages; and single-purpose reverse mortgages. Are You Eligible for a Home Equity Loan? Each lender is different in terms of what it uses to approve a home equity loan. Typically, lenders look at your credit score, your debt-to-income ratio and the available equity in your home. Credit Score Since your property’s value secures your home equity loan, lenders may approve a loan if your credit isn’t stellar. Of the lenders recommended by U.S. News, the average minimum FICO credit score for approval is 675. If yours is lower than that, you may have a hard time getting a loan approved. Those who have good credit will receive better terms and lower interest rates, and those with a score of 740 or higher may qualify for the best rates. Some credit card companies allow you to see your FICO credit score on your monthly statements. You can also purchase your score directly from myFICO.com. In addition to your credit score, check your credit report to make sure the information listed is correct, as it impacts your credit score. You can get a free copy of your credit report from the three major credit reporting agencies at AnnualCreditReport.com or by calling 877-322-8228. If you find that your credit score isn’t as high as you hoped it would be, there are ways to increase it over time. Creditors look for factors such as on-time payments, average age of open credit lines and recent hard credit inquiries. Ensure that you make loan payments on time and that you don’t apply for too much credit before applying for a home equity loan. If you can afford to do so, pay down any existing debt from revolving accounts (e.g., credit cards and lines of credit) so you can lower your utilization rate. Debt-to-Income Ratio Your debt-to-income ratio is equal to all of your current monthly debt payments divided by your monthly gross income. Lenders use it to assess your ability to repay any additional debt. To figure out your debt-to-income ratio, add up all your monthly payments and divide it by your gross monthly income (the amount you earn before taxes and deductions).

Your monthly payments may include car loans, minimum credit card payments and rent. For example, if your gross income is $5,000, and your monthly debt is $800 for a mortgage payment and $300 for an auto loan payment, you would calculate: $800 + $300 = $1,100 (your monthly debt payments) $1,100 ÷ $5,000 = 0.22 Converting the decimal into a percentage, your debt-to-income ratio is 22 percent.

The lower your debt-to-income ratio is, the higher chance you’ll get approved. The Consumer Financial Protection Bureau recommends that companies approve loans for consumers with a debt-to-income ratio no higher than 43 percent. Of the lenders recommended by U.S. News, the maximum debt-to-income ratio for loan approval is 50 percent. Home Equity You need to have home equity in order to tap into it. Your level of equity helps lenders determine how much to lend you and whether you’re required to purchase private mortgage insurance, or PMI. You usually avoid paying PMI if you have significant home equity or if your loan is a second lien against your house. Lenders will also take a look at your loan-to-value ratio, or LTV ratio, which is your home’s value compared with what you currently owe on it. For example, if the market value of your home is $300,000 and you owe $210,000, your loan-to-value ratio is 70 percent. Most lenders recommended by U.S. News may only approve loans with a maximum loan-to-value ratio of 80 percent. In other words, lenders may want your home equity, or how much you truly own the home, to be at least 20 percent. Exceptions Even if you don’t meet some of the above requirements, you may still qualify for a home equity loan. If you don’t have a great credit score, for example, you may still be approved for a loan if you have a lot of home equity and a low debt-to-income ratio. Some lenders may take your income history into consideration if you are over a certain income threshold or have a solid work history. If approved, you can typically expect a higher interest rate if you have a lower credit score.