Best Home Equity Loans of 2021 | U.S. News

Home equity loans tap the equity in your house for making home improvements, paying college tuition or handling other large expenses. For almost any need or when you want to consolidate high-interest debt, a home equity loan may be a good choice.

Comparing home equity lenders is key to finding the right one for your needs, especially as mortgage lenders have set stricter lending standards during the coronavirus pandemic. But home equity loans are still good options for borrowers who meet minimum credit score requirements and have enough equity to make them worthwhile.

Before you borrow, pause to learn more about home equity loans, including when you may want to use one. What you’ll learn here:

A home equity loan is a second mortgage that borrows against the equity in your home and uses your house as collateral to secure the loan. Tapping home equity accesses the portion of the home you’ve paid for to get one lump-sum payment without having to sell your home or refinance your first mortgage. The first mortgage is the primary loan on a property.

You can use a home equity loan for major purchases, such as paying for home improvements or college fees.

Usually, the amount you can borrow is limited to 85% of the equity in your home. The actual loan amount will depend on your income, your credit history and your home’s market value.

As with your original mortgage, your home equity loan is repaid in equal monthly payments over a fixed term. If you don’t repay the loan as agreed, your lender can foreclose on your home.

A home equity loan allows you to leverage the equity you’ve built and pay it back over time. Risk is reduced for the lender because the loan is secured by your home, which can make home equity loan rates lower than alternatives such as personal loans. But your home is at risk of foreclosure if you can’t make payments.

There are two types of second mortgages: home equity loans and home equity lines of credit. Consider both home equity options to choose the right one for you.

With a home equity loan, you receive one lump sum and repay the loan with regular payments for the loan repayment term, usually five to 30 years. Most home equity loans offer fixed interest rates, which means your interest rate never changes, and you’ll have a fixed monthly payment.

A home equity line of credit, on the other hand, is a type of home equity loan that works like a credit card. You’re preapproved for a certain amount, which is a revolving line of credit, and you can borrow as much as you need, as long as you don’t go over your limit.

Your home is used as collateral, as with a home equity loan, but payments on a home equity line of credit are not fixed. Home equity lines of credit, or HELOCs, tend to have variable interest rates that can fluctuate for the duration of your loan.

A HELOC has a draw period, which is the amount of time a borrower has to access funds from the line of credit. You’ll typically get a 10-year draw period for your home equity line and make interest-only payments during that time, after which repayment begins.

Your home equity loan amount depends on how much equity you have and your creditworthiness. Before you consider home equity loan companies, have a general idea of how much home equity you can – and want – to use.

By comparing your home’s value with your mortgage balance, you’ll know whether you have enough equity to be approved for a home equity loan and about how much you can borrow. The maximum loan amount is usually 85% of your home’s value, factoring in your first mortgage.

Let’s say your home is valued at $200,000, and you have $125,000 left on your mortgage. If a lender approves 85%, then you can borrow up to $160,000, minus the $125,000 you have left on your mortgage – meaning you can borrow as much as $35,000.

Many lenders offer home equity loans. You can get a home equity loan from a bank, a credit union or an online lender.

You may want to obtain a home equity loan from the same lender you used for your first mortgage. Your lender could get more favorable terms because you have a relationship.

You can choose from any lender that offers home equity loans.

Getting a home equity loan can be a good idea when you need one lump-sum payment to cover a long-term expense. You might use one as a home improvement loan or as a way to pay for college.

Or you could use a home equity loan or home equity line of credit for debt consolidation, but think twice before you do. That means using your house as collateral to pay off unsecured short-term debt.

Here are some features of home equity loans that can make them a good idea:

Fixed monthly payments. Unlike credit cards or variable-rate personal loans, home equity loans typically offer fixed interest rates with predictable payments. But a HELOC payment will vary depending on your balance and market rates.

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 also may be more willing to offer lower interest rates than unsecured alternatives, such as personal loans.

Tax deductions. Limited tax deductions are available for home equity loans, such as if you use home equity loan funds for home improvement projects. Consult a tax professional to figure out your exact situation.

Home equity loans can offer low interest rates and fixed monthly payments, but tapping home equity isn’t without risks or drawbacks. These are the main ones:

Equity reduction. You lose equity when you use home equity to secure a loan. Your loan amount is subtracted from the home equity you’ve built. Home equity loans also may not be a good fit if you don’t want to tie up equity for a five- to 15-year term.

Strict credit requirements. Most home equity lenders have minimum credit score requirements in the good range. You will need a FICO credit score of 700 to qualify for home equity loans with most lenders.

In addition, you will need enough income to cover your debts, including the new loan, and at least 20% home equity to qualify.

Cost. Interest is just one of the costs of a home equity loan. Home equity loan fees may be similar or identical to the fees you paid for your original mortgage.

You should expect to pay about 2% to 5% of the loan amount in fees and closing costs. Even if a lender covers some closing costs, you may have to pay for expenses such as checking your credit, getting appraisals and filing paperwork.

“Homeowners tend to forget that it costs money to take out a loan,” says Dan Green, founder and CEO of Homebuyer, a lender that helps first-time homebuyers learn about real estate.

Home as collateral. If you fail to make loan payments, you risk foreclosure, and the lender can sell your house to repay your debt.

Potentially higher costs. You could pay more for an expense if you drag it out with interest charges on a home equity loan for up to 30 years.

Immediate payment upon home sale. You must immediately repay your loan if you sell your house. If you’re using home equity funds for home improvement projects that increase your home’s value, that might cover the payment. But if your home’s value remained the same or decreased, you could find yourself with a large bill.

Even though a home equity loan can be 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.”

In that case, a home equity line of credit with a 10-year draw period might be a better choice.

Other types of home equity financing also use your home as collateral but deliver your loan funds differently. Compare home equity loans to these alternatives:

Cash-out refinancing. A cash-out refinance is a new loan that draws money out of your equity and refinances your mortgage. When you’re approved, your lender pays off your original mortgage and gives you the difference between the payoff amount and your new loan in cash. A cash-out refinance replaces your first mortgage, unlike a home equity loan, which is a second mortgage.

Reverse mortgage. Reverse mortgages are for homeowners 62 and older. The lender takes part of the equity in your home and converts it into payments to you.

Your loan amount increases and home equity declines over time. You or your estate pays the loan when you sell the house, move or pass away.

Personal loan. Personal loans are short-term loans, usually taken out for two to five years. They are generally unsecured, unlike a home equity loan that is secured by your home.

Compared with a home equity loan, a personal loan doesn’t put your home at risk of foreclosure if you can’t make payments. But you’ll pay higher interest rates with an unsecured loan than with a home equity loan.

Debt consolidation loan. If your goal is debt consolidation, a debt consolidation loan may be the best choice. Debt consolidation loans are personal loans used to pay off debt.

This type of loan can be a better choice than a home equity loan because you’re not converting unsecured short-term debt to long-term debt that’s secured by your home.

However, as with any personal loan, you should expect to pay higher interest rates than you would with a secured home equity loan.

The best home equity loan for you is one you can get approved for at the best rate with terms you can manage.

Here’s what you should use to compare home equity lenders:

Knowing whether you’re likely to qualify for a home equity loan with a particular lender can save you time and money. Research a lender’s minimum credit score and debt-to-income ratio to get a basic idea of whether you’ll meet requirements.

Then, you can prequalify for a home equity loan to get a better idea of whether you’ll be approved and to receive a rate quote.

Decide how much you plan to borrow. Some banks have minimum loan amounts, so don’t apply with lenders whose minimums you cannot meet.

Most lenders also have a maximum loan-to-value amount, and you don’t want to choose one that cannot loan you enough.

The lower your loan’s interest rate, the less the interest costs you. Try to choose a home equity loan with the lowest possible rate.

When you consider home equity loans, pay close attention to fees because they can add to the cost of the loan. Expect to pay closing costs similar to what you would pay for closing on a first mortgage, about 2% to 5% of the loan.

Other fees may apply. For example, the lender may charge prepayment penalties if you pay off some or all of your home equity loan within three years of origination.

Still, don’t let fees be your sole deciding factor. A lender may charge no closing costs but a high interest rate, which could cost more in the long run than a lender that charges closing costs but has a lower rate.

The best home equity loan is one you can qualify for at a low interest rate with repayment terms that work for your budget.