When choosing to pursue a home equity loan, you are entering into the process of borrowing money using the equity in your home as collateral. A home equity loan can be useful for large expenses such as home improvements, debt consolidation, or other unexpected financial needs.

In this article, we’ll guide you through getting a home equity loan in five steps while introducing RenoFi loans – which can offer you far more flexibility and higher borrowing power, especially if you’re planning significant renovations.

5 Steps to Getting a Home Equity Loan

If you are ready to apply for a home equity loan, follow these steps for a smooth experience.

1. Determine Your Eligibility

When approving a home equity loan, Lenders consider these factors:

  • Sufficient Equity: You’ll need a significant amount of equity in your home, often at least 15 to 20%. While some lenders offer home equity loans for up to 85% of your home’s value, the exact amount can vary.
  • Credit Score: Your chances of getting a home equity loan are much better if your credit score exceeds 620. The higher your score, the better terms you’re likely to receive.
  • Debt-to-Income (DTI) Ratio: Your lender will want to know what percentage of your income is used for debt payments. This is your debt-to-income ratio. Most lenders prefer a DTI ratio below 43%.
  • Stable Income: You’ll need to show that you have a reliable income source, as this proves your ability to repay the loan.

2. Calculate How Much You Can Borrow

Before talking to a lender, figure out how much you can borrow. You can use this formula: Home Value×LTV Limit−Outstanding Mortgage=Borrowing Power.

For instance, if your home is worth $500,000 and the lender allows a loan-to-value (LTV) ratio of 85%, you could borrow up to $425,000 minus any outstanding mortgage balance. If you owe $300,000, your borrowing power would be $125,000.

3. Shop Around for Lenders

Don’t just go with the first lender you find. Compare offers from different places, as interest rates, terms, and fees can vary significantly. Therefore, researching your options could save you money in the long run. Look for lenders who specialize in home equity loans and avoid those with unfavorable terms or hidden fees.

4. Prepare Your Application

Once you’ve selected a lender, prepare the necessary documentation. This includes:

  • Proof of income, such as pay stubs and tax returns
  • Credit report
  • Current mortgage statement
  • Home valuation or appraisal
  • Debt and expense records

Having all your documents in order can streamline the process and avoid unnecessary delays.

5. Submit Your Application

After gathering your documents, submit your application. Your lender will review your financial situation, assess your home’s value, and determine whether you qualify. This process may take a few weeks.

Once approved, you’ll receive a lump sum payment that you can use for home renovations, debt consolidation, or other large expenses. You’ll repay the loan through fixed monthly payments over a set term.

Understanding Home Equity Loans

A home equity loan allows you to borrow money using the equity in your home as collateral. Equity is the difference between the current value of your home and the outstanding mortgage balance. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, your equity is $100,000.

Home equity loans, also known as second mortgages, let you borrow against the value of your home in addition to your existing mortgage. They offer a lump sum payment and a fixed repayment schedule. This means you’ll make predictable monthly payments over the life of the loan.

How to Use a Home Equity Loan

Home equity loans can be used for different purposes depending on your financial goals and plans. Many homeowners use a home equity loan to fund renovations, repairs, or upgrades which will ultimately increase their home’s value. Others may use a home equity loan for debt consolidation, education expenses, emergency expenses, or medical bills. 

Why Choose a Home Equity Loan? The Pros and Cons

A home equity loan can be an attractive option if you need a significant amount of money at a fixed interest rate. Here are some key reasons to consider this type of loan:

The Pros

  • Fixed Interest Rate: Home equity loans usually have fixed interest rates, so your monthly payments won’t fluctuate over time. This predictability can make your budgeting easier.
  • Tax Benefits: In some cases, the interest you pay on a home equity loan may be tax-deductible, but only if you use the loan to improve your home.
  • Large Borrowing Potential: Since you’re using your home as collateral, you’ll access larger loan amounts.
  • Keep Your Rates: If your mortgage rate happens to be lower than current rates, you can potentially keep your low rate. 

The Cons

  • Risk of Losing Your Home: The loan is secured by your home, so if you fail to make the payments, your home could be foreclosed on.
  • Debt Burden: When you take on a home equity loan, you are also adding to your overall debt. This can sometimes make it harder to meet other financial obligations, especially if your income decreases.
  • More Upfront Costs: There are closing costs when you choose a home equity loan. You will also find application and appraisal fees, which can turn out to be between 2% and 5% of the loan amount.
  • Limited Use for Some Situations: Home equity loans may not be the best choice for smaller financial needs since they require borrowing a lump sum and accruing interest over time. For smaller projects, they are generally not the most cost-effective loan option.

Home Equity Loans vs Alternatives

When considering a home equity loan, it’s important to compare it to other options available to determine which is best for your financial situation. 

Home Equity Loans vs HELOCs

When you choose a home equity loan, you receive a lump sum of money, often with a fixed interest rate and fixed monthly payments. This makes it a great option for funding larger, one-time expenses. 

A HELOC, on the other hand, is a revolving credit line that comes with variable interest rates. This lets you borrow as needed but doesn’t have the payment predictability you typically have with a home equity loan.

Home Equity Loans vs Cash-Out Refinance

With a cash-out refinance, you are essentially replacing your existing mortgage with a newer, larger amount. This lets you pull out the difference in cash. While this can lower your mortgage rate, it does reset your loan term and can even result in higher interest payment totals over time. 

Home Equity Loans vs Personal Loans

Since a home equity loan is secured by your home, it often offers you lower interest rates and larger funding amounts. However, you have the risk of foreclosure if you default. A personal loan is unsecured and typically comes with higher interest rates and smaller loan amounts, but there is no risk to your home if you fail to repay. 

Why RenoFi Loans Might Be a Better Option

Most people use a traditional home equity loan to borrow money against their home. However, RenoFi offers a new and improved option that might better fit many homeowners, especially those who want to make big changes to their homes.

RenoFi loans consider your home’s after-renovation value (ARV), which can greatly increase your borrowing power (on average, 11x more) compared to a standard home equity loan.

Let’s imagine a scenario where you want to spend $150,000 to renovate your new home and increase the value of your home by $150,000:

Scenario 1 (New Home Purchase)

  • Home price: $600,000
  • Downpayment (20%): $120,000
  • Current Mortgage Amount: $480,000

Example Home Equity Loan Amount

  • $600,000 * 80% = $480,000 (80% of Total Home Value)
  • $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

  • Assuming that your renovation project will add $150,000 to your home value

  • After Renovation Value of Your Home: $750,000

  • RenoFi Loan Amount

    • $750,000 * 90% = $675,000 (90% of Total Home Value)
    • $675,000 - $480,000 = $195,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your estimated eligible loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).

Without RenoFi loans, you would not have been able to borrow the $150,000 needed to add the renovations that would increase the value of your home by $150,000. Now, with RenoFi loans, you are now able to get the loan you need to add the renovations you want to your home.

Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:

  • Home price: $600,000
  • Current Mortgage Amount: $420,000

Example Home Equity Loan Amount

  • Example Home Equity Loan % of Home Price: 80%

  • Example Home Equity Loan Amount

    • $600,000 * 80% = $480,000 (80% of Total Home Value)
    • $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

  • Assuming that your renovation project will add $150,000 to your home value

  • After Renovation Value of Your Home: $750,000

  • RenoFi Loan Amount

    • $750,000 * 90% = $675,000 (90% of Total Home Value)
    • $675,000 - $420,000 = $255,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value). 

Here’s a summary of the difference between traditional and RenoFi home loans in table form: 

In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:

  • No draw periods
  • No inspections
  • No need to give up your original loan
  • Higher borrowing limits

RenoFi loans are funded on the day the loan is closed and that is it. Take out the $195k and you get $195k in your bank and you have 20 years to pay off in equal monthly payments with interest and principal, just like a standard mortgage.

Get started with your RenoFi loan here

RenoFi Loans vs Traditional Home Equity Loans

While both loan options provide access to funds for home improvements, RenoFi loans offer several advantages:

  • No need to refinance
  • Higher borrowing power
  • Fewer draws and inspections

Conclusion 

If you’re considering a home equity loan, carefully assess your financial situation and determine if it aligns with your long-term goals. Remember to compare rates and terms from different lenders. Choosing the right home renovation loan can make or break your project. While traditional loans like HELOCs, personal, and FHA 203(k) loans have their place, they often come with limitations that can restrict your renovation plans. But RenoFi loans give homeowners a unique and flexible alternative. 

By leveraging your home’s after-renovation value, RenoFi allows you to borrow more without the need to refinance your existing mortgage or deal with complex draw schedules and inspections. Therefore, if you are a homeowner looking to maximize your renovation potential, RenoFi loans are the best choice.

Unlike traditional loans, which are based on your current home value or require you to refinance, RenoFi loans are based on the after-renovation value of your home. This allows you to borrow, on average, 11x more, get a low monthly payment, and keep your low rate on your first mortgage.

Explore your RenoFi loan options here.

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