Home Equity Loans

Mortgage loans are usually associated with buying a home, but did you know that you can borrow money based on the value of your current home? With a home equity loan, you can put your home to work for you—while it also serves as a comfortable place for you and your family to live, eat, sleep, and play. Whether you want to finance a major renovation, pay for education for yourself or your children, or consolidate debt, a home equity loan can provide you with funding at some of the lowest rates available.   

This article will cover exactly what a home equity loan is, how to qualify for one, and where to start searching for home equity loan lenders. Let’s get started. 

How Does Getting a Home Equity Loan Work?

Home equity loans allow you to borrow cash based on the equity in your primary home.  A home equity loan may be a first lien or a second lien on your home. It’s typically recommended to wait at least 3 to 6 months after getting a mortgage before taking out another loan, so your credit score has time to go back up. Depending on the down payment you made when you purchased the home and the current home values in your area, it may take years to build significant equity in your home. 

Home equity loans are a type of mortgage because they use the same collateral to secure your loan—your house. If you are unable to pay back a traditional mortgage or home equity loan, your lender can seize control of your house. Using your home as collateral allows you to borrow significantly more than you could with a personal or car loan, but it does come with risk. Because of this risk, it’s usually recommended to use these loans to further invest in yourself or those close to you by:

  • Financing home renovations that increase market value, and therefore, your equity
  • Funding education through college or trade school for you or someone in your family
  • Consolidating debt to avoid paying higher interest rates elsewhere, such as through credit card payments
  • Expanding your business

Like a traditional mortgage, home equity loans have longer terms—typically at least 5 years but could range from 10 to 30 years—and have lower interest rates than other types of loans. Indiana Members Credit Union actually offers a home equity line of credit with terms up to 40 years. Repayment schedules tend to follow monthly payments, through which require you pay accrued interest and depending on the type of the loan, the principal amount.   

How Much Can You Borrow on a Home Equity Loan?

Lenders will vary in the maximum combined loan to value (CLTV) they will allow, but it is typically 80-90%. IMCU has a home equity loan you can borrow up to 95% CLTV of the equity you have in your home (with good credit). To calculate the CLTV, let us look at an example:

Bill buys the home of his dreams for $500,000. He doesn’t have the full amount saved up, so he takes out a traditional mortgage. He makes a 20% down payment ($100,000), and his loan covers the remaining $400,000. At this point, we can calculate the maximum lending amount from the equity Bill has in his home by taking the market value times the maximum CLTV and then subtracting his mortgage principal. 

  • Market Value of Home $500,000 minus Remaining Mortgage Principal $400,000 = Equity in Home or $100,000
  • Market Value of Home ($500,000) x 95% — minus Remaining Mortgage Principal ($400,000) = Maximum Home Equity Loan Amount $75,000

Bill has $100,000 of equity in his home right after purchasing it, and can take out a home equity loan with IMCU of up to $75,000. But how does the calculation look further down the line? Over the next 10 years, Bill has his driveway redone, remodels the kitchen, and improves the curb appeal of his home with a flower bed along the front porch. This work adds to the market value of the home. During this time, he has also been making significant monthly payments on his mortgage, and his remaining principal is now $350,000. The real estate market has also improved in Bill’s favor, increasing the market value of his home by 10% since he bought it. Based on a valuation, his home now has a value of $600,000 with an outstanding mortgage principal of $350,000. Using the same calculation from above, let’s see how much Bill can take out on a home equity loan now:

  • Market Value of Home $600,000 minus Remaining Mortgage Principal $350,000 = Equity in Home or $250,000
  • Market Value of Home ($600,000) x 95% — minus Remaining Mortgage Principal ($350,000)
  • Maximum Home Equity Loan Amount $220,000

Bill still has a good credit score, so he can borrow up to $220,000 on a home equity loan.

Line of Credit vs Fixed Closed End

Home Equity Lines of Credit (HELOC) loans

  • HELOCs operate on revolving credit, so you can disburse all or a portion of your limit at a time, and as you make payment, you replenish the amount you can take out for the established draw period.
  • The term of a HELOC ranges from 30-40 years
  • HELOCs use an adjustable interest rate
  • Monthly payments of 1% of the outstanding balance are required

A Fixed Closed End Home Equity Loan

  • Disburses the entire loan amount at closing
  • The term of a Fixed Closed End ranges from 5-15 years
  • The loan uses a fixed interest rate
  • Monthly payments are fixed and determined at the time of closing the loan

How Are Home Equity Payments Calculated?

Fixed Closed End Home Equity loans are amortized loans, so you make monthly payments on a portion of the principal amount including interest. Here’s what payments would look like in our above example if Bill decides to take out a $50,000 Fixed Closed End Home Equity loans with an interest rate of 5% that he will repay monthly over 5 years (60 months):

  • Monthly Payment = Total Loan Amount / {(1 + Periodic Interest Rate)^(Total Number of Payments) -1} / {Periodic Interest Rate (1 + Periodic Interest Rate)^(Total Number of Payments)
  • Bill’s Monthly Payment = 50,000 / {(1 + (.05 / 12))^(60) -1} / {(.05 / 12) (1 + (.05 / 12)^(60)}

If you love solving equations, you would discover that Bill’s monthly payments would be $943.56. If you don’t want to trudge through the mathematics, you can use Indiana Members Credit Union's home equity loan calculator to see what your monthly payments would be (In addition to your monthly mortgage payment).  

When you start making payments on your Fixed Closed End Home Equity loan, the majority of your payments will go toward interest. But as your principal decreases, so will the amount you owe in interest, and a greater percentage of your payments will go toward paying down your principal. 

What Is the Current Interest Rate on a Home Equity Loan?

IMCU uses Prime Rate published in the Wall Street Journal as the index for Home Equity loans. Home equity loan rates are established based on the home equity loan type (HELOC v Fixed Closed End), loan amount, combined loan to value and your credit score Because of the variety of influences on what your interest rate will look like, you won’t be able to get an exact number until you speak with a lender. To start your search, visit our Home Equity page or speak with an IMCU representative

Are Home Equity Loans Hard To Get Now?

No. There is a simple application process and quicker turnaround time than a standard mortgage process. Interest rates for home equity loans are constantly changing, however, so if you are considering a loan and find a good deal, it is often best to act quickly.   

What Credit Score Is Best for a Home Equity Loan?

Home equity loan credit score requirements vary by lender, but you will generally find the best rates if you have a credit score of at least 720. So, what is the minimum credit score for a home equity loan? Minimum credit scores vary by lender. IMCU requires a score of 640 or higher. 

The best way to build your credit is to make payments for your credit cards and other debts—such as your mortgage—on time. You can also build your credit faster by spacing out major loans, like a car loan and a mortgage.  

Is It Good To Borrow from Home Equity?

Home equity loans give you access to large amounts of cash at lower interest rates than other types of loans, such as personal loans. For this reason, home equity loans are an ideal way to fund investments like renovations that will continue to increase your equity or education that can teach you new skills and increase your earning potential. 

What Are the Disadvantages of an Equity Loan?

Home equity loans have their advantages, but they have a higher barrier to entry and aren’t perfect for every borrower in every situation. Here are some of the disadvantages of home equity loans:

  • You need a home. Without owning a home, you can’t build equity to take out a loan against.
  • Your home serves as collateral. If you can no longer make payments on your loan, you could lose your home. 
  • You need a high credit score. As we mentioned earlier, if your credit score is below 620, you may struggle to find a lender, and you will likely pay higher rates.

While there can be situational downsides to a home equity loan, properly preparing and consulting a trusted advisor like IMCU can set you up for success. 

Indiana Members Credit Union: Putting Your Home’s Equity to Work

At IMCU, we’re here to support you through every stage in life. Becoming a homeowner is a big step, and that opens up even more financial opportunities. With a home equity loan or home equity line of credit, you take the value of your home—that you’ve improved through renovations or investing in a growing area—and use it to fund other areas of your life. 

If you’re ready to see how you can make your home work for you, we’re here to help. Visit your local Indiana Members Credit Union branch to start the conversation or become a member, or contact us to see how you can get started leveraging your home’s equity.