The Complete Guide To Home Equity Loans And Home Equity Agreements

A young couple sift through paperwork to compare different home equity options

Key Takeaways

  • When you take out a home equity loan, you borrow against the equity in your home. You get a lump sum upfront that you then repay in equal monthly payments at a fixed interest rate over a set term.

  • When you take out a home equity line of credit, you also borrow against the equity in your home. Your get a rolling line of credit you can tap when you need the money. You repay the money borrowed over a set term, but with variable interest rates, meaning your monthly payments may change.

  • Because your home serves as collateral, you risk losing it if you don’t make your payments.

  • To prevent foreclosure and secure optimal terms for your loan, compare different providers and build a good credit history before applying.

  • If you need cash but don’t qualify for (or don’t want to tie yourself down with) a loan, consider non-debt products such as home equity agreements (HEAs) instead.

As a homeowner, why should you care about home equity loans and home equity agreements? 

It’s simple: They can be an effective way to tap into the equity you’ve built in your home and have that equity work for you.

For instance, you could finance your next home renovation project, buy a new car or fund your children’s education.

To learn more about home equity loans and home equity agreements, how they work, and how to secure optimal terms, keep reading.

What is a Home Equity Loan?

A home equity loan (HEL) lets you borrow money against the equity in your home. The lender gives you a lump sum upfront, which you then repay in equal monthly installments at a fixed interest rate over a set term, usually between 5 and 15 years. In the meantime, your home serves as collateral. 

Home Equity Loan Full Guide: How It Works

Who Qualifies for a Home Equity Loan? 

Eligibility criteria will vary, but most lenders require the following as a minimum:

  • Credit score of 620 or higher

  • Debt-to-income (DTI) ratio of 43% or lower

  • Loan-to-value (LTV) ratio of 85% or lower

  • At least 15-20% home equity

  • How Much Can You Borrow?

You can typically borrow no more than 85% of the equity in your home. To calculate the exact loan amount or principal, lenders look at:

  • Your income

  • Your credit score and payment history

  • How much equity you have in the property

  • The current market value of your home 

How much you owe on your home, including the amount in any other home equity loans, primary and second mortgages, home equity lines of credit (HELOCs) and other liens

To assess your home’s market value, lenders may also request an appraisal.

For a rough estimate of how much you may be able to borrow, you can do some simple math:

Formulas for calculating how much home equity you could borrow

Where Can You Get a Home Equity Loan?

You can take out a home equity loan from a bank, credit union, mortgage company, or savings and loan association.

How Much Does It Cost to Get a Home Equity Loan?

Interest rates vary across providers, so be sure to shop around before taking out a loan. In addition to interest rates, pay close attention to any fees, including:

  • Broker fees

  • Appraisal fees

  • Application or loan processing fees

  • Origination or underwriting fees

  • Ender or funding fees

  • Document preparation and recording fees

These may appear as separate fees, interest rate add-ons, or “points.”

What Happens if You Don’t Repay Your Home Equity Loan?

If you fail to make your payments (default), your lender may foreclose on your property. Foreclosure is a legal process that allows a lender to recover the amount due by taking ownership of your home and then selling it. 

Lenders rarely initiate foreclosure right away. You’d typically need to miss a certain number of monthly payments first. Also, if you don’t have enough equity or are underwater – meaning the property is worth less than you owe on it – lenders are less likely to foreclose. 

In such cases, the lender may sue you for the money instead of initiating foreclosure. The lender also may repossess other properties or levy your bank accounts. All of these actions can hurt your credit score.

Can You Cancel a Home Equity Loan?

Under federal law, you have three days to reconsider a signed home equity loan without incurring a penalty. You can cancel for any reason during that time as long as the property is your principal residence. There are exceptions to this rule, so be sure to cover this topic with a financial advisor in advance.

Home Equity Lines of Credit 

Home equity lines of credit (HELOCs) are similar to home equity loans in that they allow you to borrow against your home’s equity, and in that you risk foreclosure if you default. 

Unlike home equity loans, HELOCs don’t come in the form of lump sums. Instead, you get a rolling line of credit that you can tap into whenever you need money. This can be a good solution if you aren’t sure how much you’ll need or when you’ll need it.  

Another key difference is that unlike home equity loans, which have fixed interest rates, most HELOCs have adjustable rates. This means that the interest rate and, by extension, your monthly payments, may change – and go up – over time. 

Compared to HELs, HELOCs tend to have lower signing costs, if any. 

To qualify for a HELOC, you need:

  • Credit score of 620 or above

  • LTV ratio of 85% or lower

  • DTI ratio of 43% or lower

Home Equity Agreements

Home equity agreements are not loans. There are no monthly payments, interest rates or income requirements.

Instead, your HEA provider gives you a lump sum of money up front in return for a share of the proceeds when you sell the property after the end of the term, which is usually 10 years. Until then, you get to continue living in your home and enjoy all the benefits of ownership. 

If you want to stay in the property after the end of the term, you can, by buying the HEA provider out.

To qualify for an HEA, you typically need:

  • Credit score of 550 or above

  • LTV ratio of 80% or lower

Mortgages

Home equity loans, home equity lines of credit and mortgages are loans that use your home as collateral. The primary difference is that a mortgage enables you to purchase a home in the first place. In contrast, you can only take out a HEL or HELOC after buying a property and generating at least 15-20% equity on it.

Reverse Mortgages

Like home equity loans, reverse mortgages allow you to borrow against the equity in your home. You can receive the money as a lump sum, monthly payments or a credit line.

Unlike HELs or HELOCs, you must be 62 years or older, and either own your home or have substantial equity in it – usually 50% - to qualify. You also don’t need to make repayments. The debt only becomes due when you die, sell the property or move out for more than a year.

How to Shop for HELs and HELOCs

If you’re considering a home equity loan or home equity line of credit, these tips can help you get the most cost-effective option for your needs.

1. Check Your Credit Reports

To determine your creditworthiness, lenders will look at your credit score and existing debt. Since credit scores are derived from the information in your credit reports, it is important to review your reports carefully.

You can access your reports from all three credit bureaus – Equifax, Experian and TransUnion – for free once a year at the Annual Credit Report website.

If you see errors, correct them as soon as possible by following the directions on each bureau’s website.

2. Improve Your Credit Score

Next, work on boosting your credit score, even if you meet the minimum eligibility requirements.

Pay all bills on time. Payment history can account for up to 35% of your score, so make sure to always pay utility bills, credit card, loans and all other bills on or before the due date. To ensure that you don’t miss any payments, set up reminders or automatic payments. 

  • Pay off debt early. Pay down existing debt, especially any maxed-out credit cards.

  • Don’t close credit card accounts. You can store a card in a safe place if you do not want to use it, but keep the actual account open.

  • Keep credit utilization low. Your credit utilization is the number you get when you divide the balance on a credit card by the credit limit. Aim to keep credit utilization as low as possible.

  • Don’t open multiple credit accounts at the same time. Each new application temporarily lowers your credit score, so try to space them out.

  • Use a budget. This can help ensure that you put enough money to the side to keep up with your monthly payments.

  • Protect your personal information. Hackers can use your data to open credit accounts under your name. Use strong passwords, password managers, multifactor authentication and be careful with whom you share your information.

3. Calculate Your LTV

Your loan-to-value ratio measures the relationship between the amount of your home equity loan, HELOC or mortgage and your home’s appraised value.

Lenders use LTV ratios to gauge lending risk. If your ratio is over 80%, they will likely consider you to be a high-risk borrower. You may still get approval for the loan, but at a higher interest rate.

To calculate your LTV ratio, divide the total loan amount by your home’s appraised value. Then, express the result as a percentage.

Formula for calculating your loan-to-value ratio

4. Compare Different Providers

Start by asking your current bank, credit union or lender if they offer home equity loans or home equity lines of credit. Some providers offer rate discounts for clients with multiple credit accounts or lines of credit. Plus, you may find it easier to work with a familiar lender.

Next, do some research and compare your lender’s offer with those of other providers. For best results, find at least three different lenders. Make sure to look at more than just interest rates. Consider fees, annual percentage rates (APRs) and special promotions.

Things to Watch Out For

Not all lenders have good intentions. Some target older, financially distressed or otherwise vulnerable homeowners and try to take advantage of them. 

To protect yourself and your assets, look out for the following deceptive or unlawful practices:

Loan flipping: The lender repeatedly urges you to refinance a loan. Each time you refinance, you borrow more, pay extra fees and increase your debt.

Bait and switch: The lender initially offers one set of terms but then pressures you to accept higher fees when finalizing the transaction.

Insurance packing: The lender adds insurance products to your loan that you may not need.

Equity stripping: The lender approves a loan solely on the equity you have in your home, without consideration for your ability to repay. If you can’t make the payments, you risk losing the property.

Non-traditional loans: You’re looking for a standard HEL or HELOC, but the lender offers non-traditional products, such as loans with minimum payments that don’t cover the principal and interest or loans, with low monthly installments and a large lump payment at the end of the term. 

Is a Home Equity Loan or Home Equity Line of Credit Loan Right for You?

A home equity loan or home equity line of credit can be a good choice if you have sufficient equity in your property, need cash and can afford the payments. 

If you don’t know how much you’ll need and when you’ll need it, a HELOC may be the better option.

If you need a lump sum right away but don’t meet the eligibility criteria for a HEL or HELOC, or don’t want to tie yourself down with debt, consider a home equity agreement instead.

Make the Most Out of Your Home Equity

There’s more than one way to tap into your home equity. At Unlock, we specialize in providing equity-based home equity agreements that solve problems debt can’t.

Click here to learn more about Unlock’s HEAs.