Do I have enough home equity to pay for a new roof?
The Credible Money Coach helps a homeowner understand home equity options, like cash-out refinancing and HELOCs, to fund needed roof repairs. (Credible)
Dear Credible Money Coach,
I recently lost my job, but I have a decent Social Security income that covers my mortgage. My HOA levied an $8,300 assessment for new roofs. I need a home equity loan. My property will appraise at $245,000. I owe $80,000. — Jacqueline
Hi Jacqueline, and thanks for your question. Making a home repair or improvement is a smart reason to tap into your home equity. Interest rates for home equity loans are generally lower than other loans you might consider for a home project, such as a personal loan.
Let’s look at how home equity works and some ways you can access it, including through refinancing.
Equity requirements
Whatever method you use to access your home equity, the first question you must consider is whether you have enough home equity to qualify.
Generally, lenders won’t let you borrow more than 80% of your home’s value, although there are exceptions, such as VA loans. That means if your home appraises for $245,000, the maximum you could borrow (including your mortgage and home equity loans) is $196,000 ($245,000 x .80).
If you apply for a home equity loan for $8,300 at a 6.64% interest rate with a 30-year term, your monthly payments would round out to $301, and you’d pay $731 in interest charges. You’d end up paying a total of $9,031 to finance your new roof.
Since you have an $80,000 mortgage, you have $116,000 ($196,000 - $80,000) in remaining equity. So, you have more than enough to qualify for a home equity loan if that’s how you choose to pay the roof assessment. But you also have other home equity borrowing options.
What factors affect equity requirements?
When you apply for a home equity loan, lenders will consider your credit history, debt-to-income ratio and how much equity you have established in your home.
- Credit score: You’ll need to have good to excellent credit to qualify for a home equity loan — many lenders will look for a credit score of 700 or higher, but some may accept credit scores in the 600s.
- Debt-to-income ratio: Debt-to-income (DTI) ratio requirements will vary among lenders, but aim to have a DTI ratio no higher than 43%.
- Equity: To secure a home equity loan, you’ll need to have paid off 15% to 20% of your home’s total value.
Ways to access your home equity
Tapping home equity can be a relatively economical way to get cash when you need it. However, since you put your home up as collateral, it’s wise only to spend your equity on necessities. Paying for an HOA assessment is a good use of equity since it will likely enhance your home’s value.
You have several options to access your equity, including a home equity loan, a home equity line of credit (HELOC) and a cash-out refinance.
Home equity loan
A home equity loan is also known as a second mortgage. Like your first mortgage, your home secures a second mortgage. You’ll typically need good credit and a low debt-to-income ratio to qualify.
Interest rates are usually higher for home equity loans because the lender takes on greater risk. If you defaulted and your first mortgage lender foreclosed on your home, the second mortgage company may not get paid.
A home equity loan can be a good choice when you know exactly how much you need to borrow.
If, for example, you decided to borrow the full $116,000 of your available home equity at a 6.64% interest rate with a 30-year term, you’d end up paying $10,214 in interest and $126,214 total for your loan. On the other hand, if you only borrow the exact $8,300 you need to update your roof, you’d pay $731 in interest for a total of $9,031. The smaller balance of $9,031 will be much more manageable to pay off, and will significantly reduce your interest charges over time.
Home equity line of credit
A HELOC is another way to tap your home equity. It gets secured by your home but works more like a credit card than a mortgage. Instead of receiving a lump sum and repaying it in installments over time, you receive a credit limit to tap for a set "draw period," then you begin repaying your balance.
With a HELOC, you only pay interest on the amount borrowed, not the total amount available. Home equity lines of credit typically have variable interest rates rather than fixed rates like a mortgage. That means your interest costs and monthly payments can change over time.
You might choose a HELOC if you’re unsure of the amount you need and want the flexibility to borrow as little or as much as your approved limit.
Cash-out refinance
A cash-out refinance replaces your current mortgage with a new one for a higher amount, so you pocket the difference. It’s a good option if refinancing allows you to get a lower interest rate. You can also extend your repayment term to reduce your mortgage payment. Remember that this strategy means you’ll pay more interest over the new, longer loan life.
A final word …
Every option I’ve covered comes with closing costs on top of interest charges, such as loan origination, underwriting, appraisal and other administrative fees.
Tapping your home equity can be a smart way to pay for needed repairs like a new roof. Just be sure you understand all the terms, conditions and costs before borrowing against your home equity.
And it's a good idea to compare mortgage refinance rates from multiple lenders. You can easily do this with Credible.