Alternatives to Home Equity Loans
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As a Millennial, it has been drilled into my head for years that buying a home is better than renting because it allows you to build equity. Even when going through the home-buying process, I wasn’t told much about equity — no information on what it is, how it was built, and what to do if I found myself needing dire home improvements. Unfortunately, it’s something that many of us only learn about when faced with financial hardship. Whether it’s an unexpected medical bill or an appliance suddenly giving out and needing replacement, you never know what’s just around the corner. As a homeowner, if you find yourself in need of some temporary financial assistance, you should be aware of your options.
In this article
What is a home equity loan and why would you need home equity loan alternatives?
When you purchase a home with a mortgage, you will build something called equity in your home over time. The equity of your home is equal to the difference between the appraised value of your home and the outstanding mortgage amount on the home. As long as you’ve consistently paid your existing mortgage on time, you should have some equity built up within a year. The exception is if your home’s value has depreciated since it was purchased.
A home equity loan is a loan that allows homeowners to borrow against the equity they’ve built in their home. With a home equity loan, lenders will give the homeowners a loan that is equal to the amount of their current home equity. It is also commonly referred to as a second mortgage.
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How do I find out how much equity I have in my home?
There are a few steps you can take to find out how much equity you have in your home. To get started, you can look for free home value estimate calculators online. This can give you an idea of what your current home value is, but you shouldn’t rely on this alone. You’ll also want to hire a licensed appraiser who can come to your home for the appraisal. An appraiser would have come to your home when you bought the house, so you can check with your lender to see what appraisers they recommend. You might also be able to find an appraiser through word-of-mouth and local referrals.
An appraiser will consider a few factors when determining the value of your home, including:
- The number of bedrooms and bathrooms in your home
- The square footage of your home
- Similar homes that have recently sold in your neighborhood
- The market trends of your neighborhood
After conducting the appraisal, the appraiser will put together a report which will include the appraisal value of the home. Once you have this number, you can calculate the amount of equity you have in your home. The next step is to find your current mortgage loan balance, which will be on your latest mortgage statement. Subtract your current mortgage balance from the appraised value of your home, and that will give you your current home equity.
Why would I need an alternative to a home equity loan?
Home equity loans can be a great option for some people. However, that doesn’t mean that it’s right for everyone. Like any other type of loan, there are certain requirements that you must meet to qualify for a home equity loan. The requirements are always set by the lender and could vary between lenders, but they generally include:
- Having paid off at least 15% or 20% of your mortgage
- A current credit score of at least 650
- Few or no late payments on the mortgage
- Steady income
- A debt-to-income ratio of at least 43%
In some cases, these requirements can make it difficult to get a home equity loan. In other cases, there might be an alternative loan option that is a better fit for your situation. No matter what the situation is, it’s a good idea to consider alternatives in addition to home equity loans.
Alternatives to home equity loans
Home Equity Line of Credit (HELOC)
HELOCs are a common alternative to home equity loans. Like home equity loans, HELOCs allow you to borrow from the equity you have in your home based on the amount of equity that you have built up. They can be a great option if you want a more flexible way to borrow money using your equity. However, they come with risks as well.
A HELOC is a line of credit with a draw period and a repayment period. The draw period begins as soon as the HELOC has been opened, and this is the time when you can draw money from the credit line. In most cases, you can make interest-only payments during the draw period. The draw period can vary, but they are usually around 10 years. The repayment period begins after the draw period ends, and this is when you have to make larger payments as you pay back the balance owed on the credit line as well as the interest.
The advantages of a HELOC include interest rates that are usually much lower than the rates you would get from a credit card. They also tend to have low or no origination fees or prepayment penalty fees. It can be relatively easy to obtain a HELOC from an online lender or your local bank or credit union.
If you’re considering a HELOC, you have to keep the risks in mind as well. One of the biggest risks is the fact that your home is used as collateral when you take out a HELOC. This means that if you are unable to keep up with your payments, you could find yourself facing foreclosure. It’s especially important to remember that even though you can put off big repayments until the repayment period if you don’t plan ahead for it, you could find yourself struggling to meet those payments. The variable interest rates that often come with HELOCs can also be risky and lead to dramatically larger payments if interest rates skyrocket during the lifetime of your HELOC.
Cash-out refinance
A cash-out refinance is a unique alternative that allows you to essentially convert your home equity into cash. As a mortgage refinancing option, it may be able to help you lower your mortgage interest rate and save you money on interest payments over time. In some cases, you may be able to negotiate new loan terms as well.
The process of a cash-out refinance is a bit different than some of the other home equity options. Lenders of a cash-out refinance will make an offer based on your credit profile and the balance of your current mortgage. If you accept the offer, the lender will start a new loan that pays off your previous mortgage and gives you the rest of the loan funds in cash. From then on, you’ll make monthly payments to this lender for the new loan.
Like other options involving mortgages and equity, your home is used as collateral for a cash-out refinance loan. While it can be a good idea in some cases, you should make sure you have a plan to satisfy your repayment requirements so you don’t risk losing your home. If interest rates have dropped since you took out your original mortgage, you could benefit from a lower interest rate and lower payments by refinancing. However, you also need to consider the fees and other costs that come along with refinancing, including origination fees and closing costs.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
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Alternatives that don’t involve home equity
Personal loans
If you’re in need of a loan for home renovations or other expenses, you might also consider a personal loan. Personal loans are typically unsecured, meaning they do not require collateral. With a personal loan, the lender will approve you for a lump sum of money that you will be paid all at once. It will come with loan terms, including the length of your repayment period, the interest rate, and any fees associated with the loan.
There are a few benefits to personal loans. One is that they tend to have lower interest rates than credit cards, especially if you have good or excellent credit. Personal loans are also repaid over a period of monthly payments that typically have a fixed interest rate. This makes it easier to plan for your repayments and work them into your budget.
Credit cards
Another option is to take out a new credit card. A credit card will allow you access to borrow as much as you need up to your card’s credit limit. As a revolving line of credit, you can use your credit card, pay it off, and use the funds up to the credit limit as often as you’d like.
Credit cards can offer additional perks, such as 0% introductory APRs and cash-back rewards. The revolving line of credit can also be useful long-term because you can use it for expenses over the years without taking out a new loan each time. If you’re strategic and can afford to do so, you can also avoid paying interest on your credit card by making on-time payments and paying off your statement balance each month.
However, there are some factors to consider before you apply for one. The main drawback is that it can be more difficult to factor credit card payments into your budget. Unlike loan payments, the minimum monthly payment for a credit card will depend on the amount that you’ve put on the credit card.
Companies that offer alternatives to home equity loans
If you’re looking for an alternative to a home equity loan, there are several lenders you can turn to. Each lender offers its own set of loan products and services, but there are two main categories of lenders to choose from. Here’s what you should know:
Banks and credit unions
Many banks and credit unions offer several real estate loan products, including HELOCs and other alternatives to home equity loans. When you took out a new mortgage, you may have looked at local bank and credit union lenders. These lenders may offer attractive incentives, especially if you already have some sort of bank account with them. The most common incentive is a discounted interest rate if you set up automatic mortgage payments.
Each bank and credit union will have different offerings. If a bank or credit union is already your mortgage lender, you should consider looking into what they have to offer. You might be able to find a good deal on a reverse mortgage or another product that would allow your existing lender to keep your business. That being said, you may find that a bank or credit union has higher interest rates for loan products when compared to other lenders.
Online lenders
Online lenders can offer a lot of benefits, no matter which loan product you are looking for. Since online lenders have lower overhead costs, they are often able to offer more competitive interest rates. As an online-based business, online lenders also tend to have more efficient digital applications and a quicker application process.
Costs and fees of home equity loans and alternatives
If you’ve taken out a mortgage, you probably remember the headache that is the closing costs and all of the other fees that can come along with buying a home. Whether you’re taking out a home equity loan, HELOC, or mortgage refinancing product, you’ll be facing at least some of these costs again. Common fees include:
Credit report fee: When a lender is considering you for any loan, they will look at your credit report. This will help them decide not only whether they can approve you for the loan, but it can also impact factors such as the amount of your loan, loan terms, and interest rate. The fee can vary depending on the credit service that the lender is using but can be anywhere from $10 to $100 per person. In some cases, your lender may cover the fee for you.
Appraisal fee: If you’re using your home as collateral, your lender will need to know what your home is worth. The lender might arrange to find a qualified appraiser for you, but you will be responsible for paying the fee. Usually, home appraisal fees cost between $300 and $500.
Attorney fee: You may need an attorney to review the documents that are drawn up by your attorney. It will be your responsibility to find an attorney who handles these types of transactions. The attorney may charge a flat fee or a small percentage (typically under 1%) of your loan amount.
Title fees: Part of the lender’s process will likely include a title search to ensure that there are no other liens or ownership claims against your home. Additionally, they may require a title insurance policy, which will protect the lender if an ownership claim is made against your home. Title searches typically cost under $200, whereas title insurance policies might cost up to $1,000.
Origination fee: An origination fee is charged by the lender to cover the costs of processing your application and underwriting your loan. It is typically charged as a percentage of your loan amount; usually under 1%. Some lenders might waive the origination fee entirely.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
- TrustPilot Rating 4.6 out of 5
- Connect with lenders for $0
- 100% online experience.
Pros and cons of home equity loan alternatives
Pros
- Some home equity loan alternatives offer an unsecured loan or credit option.
- Lines of credit can provide more flexibility and the ability to borrow money over time instead of one-time financing.
- Some alternatives offer a way to borrow money with fewer costs and fees.
Cons
- A home equity loan alternative might come with higher interest rates and/or more unexpected fees.
- Some home equity loan alternatives can pose a higher risk of defaulting or falling back on payments on the loan.
- In some cases, home equity loans might allow homeowners to take a tax deduction, while many alternatives do not.
The bottom line
Like any loan product, there is some value in getting a loan equity loan. There are also situations in which an alternative to a home equity loan might be a better option. As a homeowner, the best thing you can do is familiarize yourself with all of your options. Even if you don’t need a loan now, it’s beneficial to be prepared so you can make an informed decision if you’re ever in a time of financial crisis.
There are many alternatives to home equity loans. Some are also directly related to your home equity, while others are options that are available to both homeowners and non-homeowners. If you own a home, it does not necessarily mean that you should immediately utilize your home equity if you need to borrow money. But, as a homeowner, you should be aware of the benefits of your home equity, as well as the risks of using it for an assumed financial gain.
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Ashley Hart is a lead copywriter and digital marketing expert covering finance, law, real estate, music, entertainment, health and wellness.
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