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With borrowing rates remaining high on most options and home equity levels sitting at record high levels, many homeowners are eyeing their home equity as a potential source of funding for major expenses. After all, while rates on shorter-term borrowing options, like credit cards, are making borrowing cost-prohibitive, the rates on home equity products like home equity loans and home equity lines of credit (HELOCs) are much lower, so homeowners with substantial equity often find this to be the most affordable route for borrowing large sums of money.
For example, a $100,000 home equity loan can provide the capital needed for substantial home improvements, debt consolidation or other significant financial needs — and considering that the average homeowner has over three times that amount of equity currently, it’s a feasible option to consider for these or other purposes. But before you tap into what might be your biggest asset, it’s crucial to understand exactly what you’re getting into.
While these loans can be powerful financial tools when used wisely, they come with risks that shouldn’t be taken lightly — and there are a few important things to know before applying.
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$100,000 home equity loans: 5 things to know before applying
Whether you’re planning a major home renovation, consolidating high-interest debt or funding your child’s college education, understanding these five key factors can help you make an informed decision about whether a $100,000 home equity loan is right for your situation.
Your home equity amount matters more than your home’s value
Many homeowners focus on their home’s total value, but lenders care more about your available equity. Most will only let you borrow up to 85% of your home’s value minus your existing mortgage balance. This means on a $500,000 home with a $300,000 mortgage balance, your maximum available equity would be $125,000 ($500,000 × 0.85 – $300,000). In other words, you’ll need sufficient equity to qualify for that $100,000 loan, plus a cushion for market fluctuations.
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Your credit score plays a significant role
While home equity loans are secured by your property, lenders still place significant weight on your credit score. Most lenders look for a minimum score of between 660 and 680, but you’ll generally need a score of 700 or higher to qualify for the best rates. The difference between good and excellent credit can mean tens of thousands of dollars in interest over the life of a $100,000 loan, so take time to review and potentially improve your credit before applying.
Debt-to-income ratio requirements are stricter than you might think
Adding a $100,000 loan payment to your monthly obligations is no small matter. Lenders typically cap your total debt-to-income (DTI) ratio at 43%, including all mortgages, car loans, student loans, credit cards and the proposed home equity loan payment. Many borrowers are surprised to learn they don’t qualify because their DTI would be too high after adding in the home equity payment, even though they have excellent credit and substantial equity.
Fixed rates aren’t always the best choice
While fixed-rate home equity loans offer predictable payments, they might not be the best option for everyone seeking a loan for $100,000. If you plan to pay off the home equity loan early or sell your home within a few years, a HELOC with a variable rate could save you money in interest and give you more flexibility. Or, if you expect rates to drop in the future, a variable-rate HELOC could allow you to take advantage of those changes without refinancing. So, consider your timeline, the overall rate environment and your risk tolerance when choosing between the two options.
The closing costs can be substantial
Don’t forget about the closing costs tied to home equity loans, which typically run between 2% and 5% of the loan amount. On a $100,000 home equity loan, you could be looking at $2,000 to $5,000 in fees for the closing costs, which include the appraisal, title search, application and other charges. Some lenders offer to roll these costs into the loan, but remember that you’ll be paying interest on them for the entire loan term if you do.
The bottom line
A $100,000 home equity loan can be an excellent financial tool when used responsibly and under the right circumstances. The key is to understand not just whether you can qualify, but whether it’s truly the best option for your needs. Take time to shop around for rates, understand all costs involved and consider alternatives like cash-out refinancing or personal loans first to make sure a home equity loan is your best option. You should also remember that while home equity loans often offer lower interest rates than unsecured debt, they come with the serious responsibility of putting your home on the line, so make sure you have a solid plan for using and repaying the funds before moving forward.