What is a Home Equity Loan?
Published May 2, 2013 | Updated August 3, 2016
Now that home values are appreciating again, home equity loans are once again growing in popularity, thanks to pent-up demand, attractive interest rates and borrowers’ ability to deduct that interest on tax returns.
Last year the home equity balances at credit unions, for example, grew by 6.1 percent after seeing 7.2 percent growth in 2014.
If you’re considering applying for a home equity loan, you should be aware of both the benefits and risks. While rules vary by state, here’s a brief primer of how such loans work in Texas:
What is a Home Equity Loan?
Such loans allow you to borrow a lump sum at a fixed interest rate for a range of purposes, most commonly home renovations. The loan is set up like your original mortgage, with equal monthly payments spread over a fixed term. Your home, however, must be used as collateral to reduce the risk to your credit union or bank. Other popular uses for such loans include college tuition, debt consolidation, the establishment of an emergency fund or the purchase of a vehicle. Interest rates vary considerably from vendor to vendor.
Due to government regulations the loan process generally takes an average 30 days for completion, after which Amplify Credit Union can offer you your money within four days. The interest on your loan will be tax deductible.
Your chances of receiving such a loan are based on your credit history, equity and income compared to monthly debt obligations.
What is Home Equity?
The equity you’ve accumulated in your home is the difference between how much your house is actually worth (i.e. appraised or market value) and how much you still owe on the related mortgage or mortgages. That amount represents the collateral that guarantees you’ll repay your new debt. Due to Texas law, the maximum home equity amount lenders can issue for such loans is 80 percent. The system works especially in your favor when the value of your home has significantly risen since your mortgage was issued.
How Does a Home Equity Loan Work?
The process isn’t as labor-intensive as applying for a mortgage. And in Texas, certain restrictions are attached to the loans themselves that better protect you as a borrower.
During your consultation, your lender will want documentation of your credit history, debt-to-income value and loan-to-value ratio. Plan to bring your last W-2 and tax return, any earnings statements and any other loan agreements.
Your lender will access your credit report on its own, but you can preview it yourself by securing a free annual credit report provided you by federal law. Beyond that, lenders will seek proof of how long you’ve been working at your current job and in your current field. They’ll also compile your debt-to-income ratio, assessing how much of your monthly income now goes toward your mortgage, credit cards, car payments. After factoring in your loan request, most lenders seek a total ratio of less than 36 percent. To determine your loan-to-value ratio to establish your home equity, the lender will seek an appraisal of your home.
If all goes well, the lender will confirm administrative fees, closing costs and interest rates incorporated in the loan. In Texas, your fees are limited to 3 percent of your total loan.
In assessing interest, be aware of which rates are introductory and which will extend over the life of the loan. Amplify is among lenders that don’t charge penalties if you pay off your loan early.
Most home equity loans are paid off on schedule as intended, but defaults happen. Most lenders begin foreclosure two to three months after you start missing payments, placing a lien on your home that could have an effect on your credit rating equal to defaulting on a mortgage.
To avoid risk, you should have a plan in place to repay the loan even if you lose your job, make poor investments or encounter a drop in real estate prices.
How are Home Equity Loans Different in Texas?
Because of its strong emphasis on consumer protection, Texas didn’t allow home equity loans until 1997, and still imposes regulations specific to the state. Among them:
- Your Home Equity Loan and Mortgage balance(s) cannot exceed 80 percent of the value of your home at the time you take the loan.
- You may hold only one home equity loan at any given time.
- You are limited to one home equity loan per year whether you’ve paid it off or not.
- Your loan only applies to the (one- to four-family) housing unit in which you live, not your second home or rental property. If your land is listed on tax forms as “agricultural” or “open space,” it doesn’t apply.
- You can’t convert your home equity loan to any other type of loan. Even after closing, you can cancel the loan without penalty or charge within three days.
Have ideas for your Home Equity Loan? We offer terms of five, 10, 15, and 20 years with funds available four days after closing, and no prepayment penalties for paying extra on your Home Equity Loan or paying it off early.