Homeowners who need to borrow money should consider home equity as a source of funds. Two factors increase your home equity: an increasing home value and a decreasing mortgage balance. Thanks to a general upward trend in U.S. home prices, many equity-rich homeowners could find opportunity in home equity loan products.
What’s the deal with interest rates in 2019? You may have noticed interest rates on savings accounts and debt products crept upward last year. In 2018, there were four federal funds rate increases. This benchmark is used by banks, lenders and creditors to set interest rates.
“Home equity rates typically move fairly closely with the fed funds rate,” said Tendayi Kapfidze, chief economist at LendingTree, the parent company of Student Loan Hero. According to Kapfidze, two rate hikes are projected in 2019. “If you want to avoid the risk of higher rates, act sooner than later,” he said.
Good news — your home equity loan may qualify for a tax deduction
There was a bit of confusion in 2018 about whether interest can still be deducted on home equity loans. Under the new tax law, interest on home equity loans is still deductible with conditions. According to the IRS, for interest to be deductible, the loan must be “used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
This means that interest deductions cannot be taken for home equity loans used for education, debt consolidation or other personal reasons. You may be able to take interest deductions on up to $750,000 worth of loans on qualified residences. The loan limit for married people filing separately is $375,000. Speak with a tax professional to determine if you qualify.
What to expect for home equity loan interest rates
Several factors, including your credit, loan amount and home equity, can affect your interest rate. Shop around with multiple lenders to see what each one has to offer.
Currently, the interest rate on a $100,000 home equity loan can start as low as 4.25% in the LendingTree loan marketplace. Interest rates for home equity loans of $25,000 to $50,000 can be as low as 5% to 6%. Keep in mind the most competitive rates are usually given to borrowers with the best credit.
For national averages, FICO has a spreadsheet that lists average interest rates for home equity loans by credit score. Here’s the interest rate breakdown (as of time of publishing) by credit score for a $50,000 home equity loan with a 15-year term:
- 740+: 6.605% APR
- 700 to 739: 6.905% to 7.405% APR
- < 700: 8.180% or higher
Credit and equity requirements
Below is what you need to know about home equity loan requirements:
Credit: Credit score requirements can vary by lender. Decent credit is usually necessary to get approved for a home equity loan, and the best rates are generally given to borrowers with credit that’s good or better.
Loan-to-value (LTV) ratio: The LTV ratio is a factor lenders consider to determine if you have enough equity in the home to borrow. To calculate LTV, divide your mortgage balance by your home’s market value and multiply by 100 to get a percentage. Lenders typically look for borrowers who have an LTV that’s below 80%. Lenders may also calculate your CLTV, or combined loan-to-value ratio. This ratio takes into account your present mortgage balance plus the home equity loan you’re requesting. The requirement for CLTV can vary as well.
Debt-to-income (DTI) ratio: Lenders make sure that you can manage another debt payment by checking your DTI ratio. Calculate your DTI by dividing your monthly debt payments by your monthly income. You typically need a 43% DTI or lower to qualify.
How much you can borrow: Lenders will generally lend up to 80% or 85% of your home equity. However, the amount you’ll be able to borrow will depend on your income, credit and home value.
Risks and rewards of home equity loans
- Fixed rate and period. Home equity loans can offer a fixed interest rate for a fixed term. This gives you payments that are predictable and stable. The fixed term often ranges from five to 15 years.
- Competitive interest rates. Home equity loans are backed by the value of your home. A product with collateral backing may help you secure a lower interest rate than what’s available for unsecured products like a personal loan.
- You’re limited to the amount of equity available. New homeowners with minimal home equity may not be eligible for a home equity loan product. Long-term homeowners are also limited in the amount they can be borrow because of the equity requirements.
- The implications if you can’t pay. The collateral aspect of the loan also has a downside. Your home can go into foreclosure if you can’t make home equity loan payments.
- The fees and fine print. Home equity loans may come with various application, appraisal, origination and funding fees. There may also be prepayment penalties if you pay off the loan early or sell the home. Read the fine print carefully and do the math to make sure you understand all costs.
Choosing the right type of loan
In addition to the home equity loan, homeowners can tap into equity by using a cash-out refinance or home equity line of credit. Here’s an overview of how each one works.
Home equity loan
How it works: As mentioned, the home equity loan is an installment loan that gives you a fixed amount of money that you need to pay back within a fixed term. You should shop with multiple lenders to get an idea of the interest rates, terms and fees that are available. Once approved, you make payments on the home equity loan until the loan term ends.
Best for: It’s best for people who prefer a lump-sum installment loan product. A home equity loan can be used for such things as consolidating debt, financing an education, paying for medical procedures or making home improvements. Check out our guide on home equity loans to learn more.
How it works: The borrower refinances a mortgage for more than the existing loan amount and takes cash out of the deal. For example, if your current mortgage balance is $200,000, you can refinance for a mortgage of $220,000 and take $20,000 out in cash.
Best for: You can improve the terms of your present loan (i.e., lower your rate) while also getting access to some cash. Be careful of the processing fees required to refinance your loan. These costs cut into the amount of money you get from cashing out. Learn more about the cash-out refinance here.
Home equity line of credit (HELOC)
How it works: A HELOC is a credit line backed by your home. Home equity lines of credit typically have a draw period followed by a repayment period when you have to pay the money back. Home equity lines of credit can have variable interest rates.
Be sure to ask about the periodic and lifetime rate caps for a HELOC. Home equity lines of credit may also have low introductory rates and interest-only payment options that can cause large balloon payments at the end of the loan’s term. Read through the terms of the product before signing on the dotted line. For more information, learn about the ins and outs of home equity lines of credit in this post.
Best for: An installment loan can be a good idea for homeowners who need access to an unknown amount of cash. For example, unexpected expenses can pop up when remodeling a home. A credit line can allow you to get money when you need it. Interest for a home equity line of credit may also be deductible, if you’re using it to make eligible home improvements. Speak with a tax professional for details.
Borrowing money using home equity isn’t a decision you should make lightly. Your home can be put into jeopardy if you have trouble making payments. However, tapping into your home equity can be an affordable alternative to other products when you need cash. Shopping around will help you find the best possible product. LendingTree, the company that owns Student Loan Hero, has a marketplace where you can see your personalized offers from various lenders based on your creditworthiness.
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