Equity loans allow homeowners to leverage the equity in their home to access cash. There are several different types of equity loans available each with their own pros and cons. In this article I’ll explain the 7 most common types of equity loans to help you understand your options.

1. Fixed-Rate Home Equity Loan

This is the most common and straightforward type of equity loan. You receive a lump sum payment upfront, which you pay back in fixed monthly installments over a set timeframe, usually 5-15 years.

The interest rate and monthly payments remain the same over the life of the loan. This provides predictability in your budgeting since the payments don’t fluctuate.

Fixed-rate loans are best for one-time cash needs like home renovations, medical bills, or consolidating high-interest debt. The longer loan term keeps payments manageable compared to other types of financing.

2. Home Equity Line of Credit (HELOC)

A HELOC works more like a credit card than a traditional installment loan. You have an open line of credit with a set limit, usually up to 85% of your available home equity. You can draw from this line as needed, then repay it over time.

HELOCs have variable interest rates, so your monthly payments fluctuate based on the market. Many have a 10-year draw period where you can access funds, followed by a 15- or 20-year repayment period.

The flexibility makes HELOCs a good option for ongoing or unexpected expenses like home improvements or medical bills. You only pay interest on what you actually use.

3. Cash-Out Refinance

With a cash-out refinance, you take out a new mortgage loan with a higher balance than your existing mortgage. This frees up cash from your equity while consolidating debts into one lower monthly payment.

For example, if your home is worth $300,000 and your current mortgage balance is $180,000, you may qualify to refinance for $210,000. That extra $30,000 cash can pay for renovations, college tuition, or other big expenses.

The catch is that cash-out refinances come with higher closing costs than other types of equity loans. Make sure the long-term interest savings outweigh the upfront fees.

4. FHA 203(k) Loan

FHA 203(k) loans allow you to finance the purchase and renovation of a home in a single mortgage, including both the home price and estimated renovation costs.

To qualify, the property must need at least $5,000 in renovations. The total mortgage is based on the expected value of the home after the work is complete.

203(k) loans can be easier to qualify for than a traditional renovation loan. They’re backed by the Federal Housing Administration, so down payments as low as 3.5% are allowed.

5. FHA Title I Home Improvement Loan

Another FHA option, Title I loans provide up to $25,000 for renovations and repairs to an existing home. You can use the funds for everything from new siding to swimming pool repairs.

These government-backed loans feature low down payments, flexible credit requirements, and loan terms up to 20 years. You don’t need as much equity as other home equity loans.

Closing costs are limited to just a few hundred dollars. However, Title I loans have higher interest rates and stricter loan limits than other products.

6. HomeStyle Renovation Mortgage

Offered by Fannie Mae, the HomeStyle loan combines your home purchase or refinance with funds for renovations. Loan amounts go up to 95% of the home’s value.

You can finance major renovations like adding rooms or upgrading plumbing and electric. Improvement costs are rolled into your primary mortgage balance.

HomeStyle loans offer low down payments, and some even waive the usual 20% equity requirement for cash-outs on refinances. This flexibility comes with higher closing costs.

7. Energy Efficient Mortgage (EEM)

An EEM offers financing for energy-saving upgrades to both existing homes and new purchases. Improvements like solar panels, insulation, and new windows can be added to your mortgage.

EEMs provide mortgage insurance premium discounts up to .25%. Energy savings offset some of the cost of the improvements, so borrowers can qualify for higher loan amounts than traditional loans.

Not all lenders offer EEMs. Be sure to shop around for the best rates and a lender experienced with these specialized loans.

Key Factors to Consider With Equity Loans

When weighing the different types of equity loans, there are a few key factors to keep in mind:

• Interest rates and fees: Compare both closing costs and ongoing interest rates across loan products. Lower rates help you save over the long run.

• Loan amount limits: Each program has maximum limits on how much cash you can access based on your equity, income, and credit score. Know what you’ll qualify for.

• Collateral requirements: Most equity loans require at least 15-20% equity. Cash-out refinances often need 20%. Check your current home value and loan balance.

• Credit score requirements: In general, you’ll need a score of at least 580-620 for most equity loans, though better scores snag lower rates.

• Loan term: A shorter term means you’ll pay off the debt faster. But longer terms of up to 30 years have lower monthly payments. Find the right balance for your budget.

• Prepayment penalties: Home equity loans don’t typically charge penalties for early payoff. But make sure to verify this if you may sell your home or refinance soon.

When an Equity Loan Makes Sense (and When It Doesn’t)

Equity loans can be useful for major expenses, debt consolidation, and renovations. But they aren’t right for everyone.

You may want to avoid tapping your home equity to pay for:

• Everyday expenses or smaller purchases like appliances
• Business or investment activities
• College tuition that doesn’t increase the long-term value of your home

In some cases, an equity loan is too risky or expensive:

• If you have less than 15% equity available
• If your credit score is below 580, impacting loan eligibility
• To pay off lower interest debt like federal student loans

Before applying, make sure an equity loan aligns with your financial goals. Shop around to find the best product for your needs.

How Much Can You Borrow Against Your Home Equity?

When applying for a home equity loan, lenders will assess how much cash you can safely access while keeping some equity cushion in your property. Here are the main factors that determine your borrowing power:

Loan-to-Value (LTV) Ratio

Your LTV compares the loan amount to the home’s value. Most lenders cap equity loans at 80-85% LTV to limit their risk.

For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, you have $200,000 in equity. At 80% LTV, your max equity loan would be around $160,000.

Combined Loan-to-Value (CLTV) Ratio

The CLTV adds up all loans on the property, including first and second mortgages. Most lenders want this ratio to stay under 80-90%.

Using the same example, if you already have a $300,000 mortgage, plus you take a new $160,000 equity loan, your CLTV is now 80% ($460,000 divided by $500,000).

Credit Score

Most lenders require a minimum credit score between 580-620 for approval. But borrowers with scores of at least 760 qualify for the very best rates.

Debt-to-Income Ratio (DTI)

Lenders look at your total monthly debt payments, including the new loan, in relation to your gross monthly income. DTIs above 45% often face limited loan options.

Home Value

A higher home value provides more equity borrowing power. Get the most accurate picture with a professional appraisal.

Check your potential borrowing amount with an online home equity calculator. Remember to only borrow what you reasonably need and can fit in your budget.

4 Tips for Getting the Best Equity Loan Rates

Follow these tips to make sure you get the lowest rate possible on a home equity loan or line of credit:

1. Have a credit score over 760. Excellent credit snags the top rates on equity loans, so wait until your score is over 760 before applying. Pay down debts and correct any errors on your credit reports.

2. Shop around with multiple lenders. Compare quotes from banks, credit unions, and online lenders. See who offers the lowest rate for your specific financial situation.

3. Opt for shorter loan terms. You’ll pay less interest over time with a 10 or 15-year equity loan term versus 30 years. Just make sure you can manage the higher monthly payment.

4. Make a larger down payment if possible. Putting down at least 20% equity shows lenders you’re financially stable and lowers rates