Home equity loans let you borrow against the equity you have stored in your home. Equity is the difference between what your home is currently worth and what you owe on your mortgage.
To qualify for a home equity loan, you need to have built up enough equity to meet your lender's basic criteria. You also need good credit, a steady income, and not too much debt. Read on to find out everything you need to know about the requirements for home equity loans!
5 Basic Requirements for Home Equity Loans
Different lenders may have a range of requirements to qualify for a home equity loan. For example, there may be variations in the minimum amount of equity or the minimum credit score needed. Keep in mind that the loan process may take a few weeks, from the time you apply to when you receive your funds.
In general, you’ll need to meet the following criteria:
1. Enough Home Equity
It's a good idea to have at least 20% equity built up in your home before you take out a home equity loan, as this protects you in case the real estate market falls and your home loses value. But some lenders may offer a home equity loan if you have just 10% equity.
2. Good Credit Score
You will likely need a credit score of at least 660 to qualify for a home equity loan, though some lenders may consider lower scores if your finances are generally in good shape. Keep in mind that higher scores get lower interest rates.
3. History of Timely Debt Repayments
Your repayment history is part of your credit score, but lenders may take a closer look at this section of your credit report to decide if you're a safe bet for a home equity loan. It's a big commitment for both you and your lender because your home can be seized in case of default.
4. Low Debt-to-Income (DTI) Ratio
To work out your DTI ratio, add up all of your legally binding debts, such as credit cards and loans, and divide it by your total household income from all sources. Most lenders want your DTI to be under 43% but others may be more strict or more relaxed, with a range of 36% to 50%.
5. Sufficient Income
As well as qualifying for a home equity loan, you need to show you can comfortably afford the monthly payments. This is why lenders will want to see evidence of steady employment with proof of income from all sources, including jobs, rentals, alimony, or child support.
Tips to Meet the Requirements for a Home Equity Loan
Maybe you've done your homework and decided a home equity loan is the right financing tool for you and your family, whether you want to use the funds for renovations or maybe even to get a down payment to buy another home.
But if you're not confident you can meet the qualifying criteria, here are a few ways to improve your chances of having your home equity loan approved.
Improve Your Credit Score
Take a look at the factors that go into your credit score and figure out ways to improve each part. Here's what goes into your FICO credit score and some quick tips to keep you on track:
- Repayment history (35%): Be sure to make all your payments on time so you get a good score in this category.
- Credit utilization, or your debt-to-credit ratio (30%): Avoid maxing out your credit cards and try to use less than a third of your total available credit.
- Length of credit history (15%): Keep old credit card accounts open with a zero balance after you pay them off.
- Mix of credit (10%): It's a good idea to hold a range of loans at different times, like a credit card, auto loan, personal loan, and home loan.
- New credit applications (10%): Avoid applying for many different types of credit in a short time as these will temporarily ding your credit.
Pay Down or Consolidate Your Debt
If your DTI and credit utilization rate are high, you want to explore ways to better manage your debt. Here are a few ideas:
- Consolidate debt with a balance transfer credit card or a personal loan
- Use the avalanche or snowball method to tackle multiple credit cards. This means you pay off debts with higher rates first, or you pay off debts with lower balances first.
- If you don't want to consolidate, you could try extending your existing loan terms to give you more money each month (but this means you'll pay more total interest).
- You may even have an existing home equity loan you could refinance to get a lower rate or monthly payment.
Boost Your Income
If you can't shift your debt, look for ways to earn more income:
- Find a side hustle
- Get a night job
- Ask for a raise
- Get creative and sell your wares online
Wait Until Your Ratios Improve
The last tip is to simply wait. In a few years, your home may have gained in value while you've been steadily paying down your mortgage. This means you'll have more home equity and less debt, so your chances of meeting home equity loan requirements will be better.
Home Equity Loan Borrowing Limits
The amount you can borrow through a home equity loan will be determined by several factors, including how much your home is worth and how much equity you've built up. Here are a few ways to find out your potential borrowing limit.
Get a Home Appraisal
You can hire a professional to get an accurate home appraisal or use an online real estate app to get a rough idea of what your home is worth. Your lender may also have a preferred appraisal company.
Find Out How Much Home Equity You Have
The amount of equity you have in your home has an impact on whether or not you're approved for the loan, and how much you can borrow. To work out your home equity:
- Take the current market value of your home, say, $300,000.
- Subtract your current mortgage balance, say, $225,000.
- This means you have equity of $75,000.
- You may be able to borrow between 80% to 100% of your home equity, depending on your lender.
- To turn the dollar figure into a percentage, divide your equity ($75,000) by the market value ($300,000) = 0.25 or 25% equity.
Calculate Your LTV and CLTV
Lenders will likely look at your loan-to-value (LTV) ratio and combined loan-to-value ratio (CLTV) to determine how much you can borrow.
- For your LTV, divide your mortgage balance by your home value: For example: $225,000/$300,000 = 75% LTV (or 25% home equity).
- For your CLTV, add your mortgage balance to how much you want to borrow. For example: $225,000 mortgage + $25,000 home equity loan = $250,000.
- Your CLTV may need to be less than 85% of your home value, depending on your lender.
- In this example, the CLTV of $250,000 is 83% of the $300,000 home value, so a borrowing amount of $25,000 could be approved!
Next Steps: Choose Your Home Equity Loan Provider
The basic requirements for a home equity loan can help you decide if you'll qualify, but the final decision will come down to your chosen lender. That's why it's important to choose a friendly, local financial institution like Greater Texas Federal Credit Union.
We know what people in the Greater Houston area need and want—and we can help you achieve your goals with our home equity loans. Enjoy low rates and no closing costs! Click below for details.