If you are wondering how a home equity line of credit and a home equity loan work, then you’re not alone. Many people confuse home equity loans and a HELOCs. If you’ve built up home equity
and would like to tap into that, you may want to consider a HELOC or a home equity loan for a variety of reasons. Here’s the difference between HELOCs vs home equity loans and tips on how to qualify.
How Does a Home Equity Line of Credit Work?
With a home equity line of credit, or HELOC for short, you can take out money as you need it during the draw period, which is determined by the lender. This is similar to a credit card, in that once you pay off what you’ve borrowed, you can borrow more.
For example, if you take out a $6,000 home equity line of credit
and pay $3,500 toward the principal, you’ll have $2,500 in available credit. With HELOCs, the interest rates are variable and your payments are based on how much credit you’ve used, as well as the current interest rate.
What is a Home Equity Loan?
A home equity loan allows you to take out a lump sum of money, like a personal loan. Like a home equity line of credit, your home equity loan will be determined based on the value of your home and your mortgage balance. With a home equity loan, your interest rate is typically fixed, and your repayment amount is the same each month. In contrast to a HELOC, you can’t keep taking out money once you’ve paid back the principal.
How to Get a Home Equity Loan or Line of Credit
To qualify for a home equity loan
, lenders will look at your debt-to-income ratio, or DTI, to figure out how much of your income is already promised to other lenders. This factor helps lenders determine if you’re a good fit for this type of loan. Typically, the lower your DTI, the greater chance you have to qualify for a home equity loan or line of credit. Lenders look for your DTI to be under 36%; however, Fannie Mae and Freddy Mac typically allow up to 45% DTI. If you aren’t there yet, try to pay down your debt or reduce your other monthly expenses.
Mortgage lenders will consider your loan-to-value ratio, or LTV, too. This is the amount you still owe on your mortgage divided by your home’s current market value. To make sure your home’s value is accurate, you’ll need an appraisal. Typically, the lower the ratio, the better your chances of qualifying. Typically, LTV ratios need to be 80% or below to qualify for a home equity line of credit. Lenders need to keep a cushion of about 20% equity in the home to use in case they need to foreclose and sell the home if payments aren’t made.
E-Central Credit Union in California offers Home Equity Loans and HELOCs
to Southern California members throughout Los Angeles County. If you’d like to learn more about our home equity options or to apply for a home equity loan or line of credit, contact our home loan officers
or give us a call