What’s required to get a home equity loan?
Securing a home equity loan requires meeting specific lender criteria to ensure you have sufficient equity and can repay the loan. Key requirements include:
- Percentage of equity in your home: Typically, you need at least 15%–20% equity in your home to qualify.
- Credit score: A higher credit score can improve your chances of approval and secure better interest rates. Most lenders look for scores above 620.
- Debt-to-income ratio (DTI): Lenders usually require a DTI ratio below 50%, with a preferred target of below 43%. This ratio helps lenders evaluate if you can handle additional debt.
- Income history: A steady income history reassures lenders that you have the means to meet monthly payments.
- Home appraisal: An appraisal is usually necessary to confirm your home’s current value and the equity available for borrowing. However, some lenders may offer options that don’t involve a full appraisal.
How much does a home equity loan cost?
The cost of a home equity loan is not just about the interest you pay but also includes closing cost fees, which generally range from 2% to 6% of the loan amount.
For example, if you take out a home equity loan of $75,000, you can expect to pay between $1,500 and $4,500 in closing costs. Here is a list of the fees that can be included in your closing costs:
- Origination fee
- Credit report fee
- Appraisal fee
- Document preparation fee
- Title search fee
- Title insurance policy
- Notary fee
- Attorney fee (in states where required)
You’ll also want to check your loan agreement for additional costs, such as annual fees for maintaining the loan or early repayment penalties that some lenders charge to offset their loss of expected interest income.
Example home equity loan payments
| Loan term | Loan amount | Interest rate | Monthly payment |
| 30-year | $75,000 | 9.15% | $611.58 |
| 20-year | $75,000 | 9.10% | $679.63 |
| 15-year | $75,000 | 9.10% | $765.17 |
| 10-year | $75,000 | 9.10% | $954.13 |
| 5-year | $75,000 | 9.10% | $1,560.52 |
Source: U.S. Bank home equity loan calculator (As of May 2024 with a 730 credit score)
When choosing which term length is best for you, consider your monthly budget. As you can see in the table above, a shorter-term loan can have a lower interest rate. The rate you pay will depend on your credit score, loan length, and the lender. It’s wise to shop around and compare interest rates.
Are there drawbacks to home equity loans?
While home equity loans can provide significant financial resources, they come with some potential drawbacks:
- Fixed loan amount: Unlike a HELOC, a home equity loan offers a lump sum, which means you can’t borrow additional funds without a new loan.
- Closing costs and fees: Home equity loans often involve closing costs and fees, which can add up to 2%-6% of the loan amount.
- Impact on future finances: Taking out a home equity loan reduces the equity you have in your home, which could impact your financial flexibility in the future.
- Risk of foreclosure: Since your home serves as collateral, failure to make payments can lead to foreclosure.
Alternatives to home equity loans
If a home equity loan doesn’t fit your financial goals or if you’re looking for different borrowing options, consider these alternatives:
- Home equity line of credit (HELOC): Unlike a home equity loan, a HELOC offers a revolving credit line to borrow from as needed, with variable interest rates.
- Personal loans: If you prefer not to use your home as collateral, a personal loan might be a suitable option. These loans often come with higher interest rates but less risk of losing your home.
- Cash-out refinance: This involves refinancing your current mortgage for more than you owe and taking the difference in cash. It can be a good choice if you can secure a lower interest rate than what you currently have.
- Credit cards: For smaller or short-term financing needs, credit cards could be a feasible alternative, especially if you can take advantage of promotional zero-interest offers.
- Retirement plan loan: Some retirement plans, such as a 401 (k), allow you to borrow from your retirement savings. The loan amount may be limited to a percentage of your vested balance or a capped amount.
- Government loans: Some government programs can provide financial assistance for home repairs and improvements, potentially offering more favorable terms than traditional home equity loans.
