What is a Leverage Home Equity Loan and How Does it Work?

Owning a home is often considered part of the American dream. Beyond just having a place to call home, homeownership also comes with the ability to build equity in your property over time. As you pay down your mortgage, your equity stake in the home increases. This equity can be a valuable financial resource that savvy homeowners may look to leverage through home equity loans.

What is Home Equity?

Home equity refers to the current monetary value of your ownership stake in the home. It’s calculated by taking the current market value of the home and subtracting any outstanding mortgage debt still owed on the property.

For example, if your home is worth $500,000 on the current market and you owe $300,000 still left on the mortgage, your home equity would be $200,000 ($500,000 – $300,000 = $200,000).

Home equity builds over time as you pay down your mortgage principal and as the property value potentially appreciates. It provides homeowners with a pool of money that can be tapped through things like home equity loans and home equity lines of credit (HELOCs).

What is a Home Equity Loan?

A home equity loan is a type of loan that allows homeowners to leverage their equity as collateral to obtain a lump sum of cash.

With a home equity loan you receive the full loan amount upfront as a single disbursement. The loan is then repaid over a set repayment term usually between 5-30 years, with a fixed interest rate and fixed monthly payments.

The loan amount is limited to a percentage of your equity value, often around 80-85% depending on the lender. So if you had $100,000 in equity, you may qualify for a home equity loan up to around $80,000 – $85,000.

How Does a Leverage Home Equity Loan Work?

Here are some key things to understand about how leverage home equity loans function

• Use home equity as collateral – The equity in your home secures the loan, meaning your home is used as collateral. If you default, the lender can foreclose and force a sale of the home to recoup the unpaid loan balance.

• Fixed interest rate – Home equity loans have fixed interest rates, meaning your interest rate stays the same over the full loan repayment term. This provides predictability for budgeting the monthly payments.

• Fixed monthly payments – Your monthly payments stay the same over the life of the loan and are structured to pay back both principal and interest amounts.

• Access a lump sum – With a home equity loan, you receive the full approved loan amount upfront as a single disbursement of cash that you can use for any purpose.

• Repayment term – Standard repayment terms are usually between 5-30 years. Longer terms mean lower monthly payments but higher total interest paid over the life of the loan.

• Tax deductible – If used for certain purposes like home improvements, the interest paid on the home equity loan may be tax deductible. Consult a tax advisor to understand deductibility.

• Closing costs – There are closing costs associated with taking out a home equity loan, including origination fees, appraisal fees, and title fees. Closing costs are typically between 2-5% of the loan amount.

• Loan-to-value limits – Lenders limit the maximum loan amount you can borrow based on your equity. Typical LTV limits are 80-85% meaning if you have $100k equity, your max loan would be $80k-$85k.

• Credit score requirements – Home equity lenders generally require good credit, often 640 or higher, to qualify for the lowest interest rates. Your exact rate is based on your credit profile.

Pros and Cons of Leverage Home Equity Loans

Pros

• Access a lump sum of cash for major expenses
• Potentially lower interest rate than credit cards or personal loans
• Fixed monthly payments help budgeting
• May be tax deductible based on usage

Cons

• Home is collateral, risk of foreclosure
• Closing costs to take out loan
• Monthly payment added to your expenses
• Loan limits based on available equity

What is a Home Equity Line of Credit (HELOC)?

A HELOC is another way homeowners can leverage equity to access cash. With a HELOC, you are approved for a revolving credit line up to a certain limit based on your equity. It works similarly to a credit card. You can draw against the available credit as needed and make interest-only payments on the amounts used.

HELOCs have variable interest rates that adjust along with market rates. They give flexibility to access cash only as needed, while home equity loans provide an upfront lump sum. Each option has pros and cons to weigh for your specific needs.

How Much Cash Can You Get from Home Equity?

The amount of cash you can leverage from your equity depends on two key factors:

1. How much equity you have available – Lenders limit loan-to-value ratios to 80-85% typically. The more equity you have, the more cash you can potentially borrow.

2. Your lender’s underwriting policies – Each lender sets their own criteria for loan amounts, credit score requirements, and debt-to-income limits. Underwriting standards have tightened in recent years.

Run the numbers to see where you stand in terms of available equity and research lender’s policies. Many lenders allow you to get pre-qualified to see potential loan amounts you may qualify for.

What are Some Common Uses for Leverage Home Equity Loans?

There are a variety of reasons homeowners commonly tap into their equity through leverage loans:

• Home improvements – Remodeling, renovations, repairs
• Debt consolidation – Payoff higher interest credit cards or personal loans
• Major purchases – Fund a wedding, car, boat, vacation
• Education costs – Pay for college tuition
• Medical expenses – Pay medical bills and procedures
• Investing – Real estate investments, business startup costs

A leverage home equity loan provides access to cash that can be used for almost any purpose. It’s up to you how to utilize the funds within your budget and financial plan.

What are the Requirements to Qualify for a Home Equity Loan?

Here are some typical eligibility requirements lenders use to qualify borrowers for home equity loans:

• Home ownership & equity – You must own the home used as collateral and have sufficient equity available to leverage.

• Credit score – Minimum credit scores vary by lender but often 640+ for the best rates. Higher scores get lower rates.

• Income – Documented income to prove ability to repay the loan. Lenders may require minimum income thresholds.

• Debt-to-income ratio – Your total monthly debt payments, including the new home equity loan payment, divided by gross monthly income. Typical DTI limit is around 43-50%.

• Loan-to-value ratio – The loan amount versus home value. LTVs on home equity loans are capped at 80-85% depending on the lender.

• Home appraisal – The lender will require an appraisal to confirm current home market value and available equity amount.

Meeting the basic eligibility criteria is a good starting point for approval, but final loan offers also depend on individual underwriting.

What are the Steps to Getting a Home Equity Loan?

If you need cash and are considering tapping your home equity, follow these general steps:

1. Check your equity – Confirm you have enough equity available to make borrowing worthwhile.

2. Compare lenders – Research multiple lenders and get rate quotes. Compare fees, rates, terms.

3. Complete loan application – Apply with your chosen lender and submit all required documents.

4. Home appraisal – The lender will schedule an appraisal to validate home value.

5. Loan approval – It takes roughly 2-4 weeks to get loan approval once the application is complete.

6. Closing & funding – Approved loans can typically close and fund in about 2-6 weeks depending on the lender.

7. Receive funds – At closing, you’ll sign documents and receive the lump sum disbursement.

8. Begin repayments – Loan repayment starts the following month on your set due date.

Be sure to consider both the benefits and risks before moving forward with a home equity loan or line of credit. Use caution and leverage equity only for well-planned purposes that fit within your overall financial goals.