Who is eligible for a home equity loan?
The most important home equity loan requirement is that you have enough equity to borrow. The good news is that most US homeowners are sitting on a lot of pent up cash. According to CoreLogic, the average borrower earned $63,600 in home equity between 2021 and 2022 alone.
In addition to having sufficient net worth, you will need to meet minimum credit score requirements and have a stable income to qualify for a home equity loan. These requirements are flexible from lender to lender and many homeowners may qualify.
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Typical home equity loan requirements
Most mortgages must comply with rules set by Fannie Mae and Freddie Mac or by a government agency. But it’s not like that with home equity loans. Each lender decides on their own home equity loan requirements and these can vary widely from company to company.
Below are typical home equity loan requirements that you are likely to see from many banks and lenders. Some might be more lenient than others, but note that if your loan is borderline or considered higher risk, you might pay higher interest rates and closing costs as a result.
Minimum home equity required to qualify
Most lenders want you to keep 20% of your home’s value as a financial cushion. This means that you can usually borrow up to 80% of the value of your home between your main mortgage and your second mortgage combined. In other words, you will need After more than 20% equity to qualify for a home equity loan.
Here is an example :
- Your house is worth $400,000
- Your current mortgage balance is $200,000
- Your maximum combined loan amount is $320,000 (80% of $400,000)
- The maximum amount of your home equity loan is $120,000 ($320,000 minus existing loan balance)
Remember that your total equity is the difference between the value of your home and the amount of your principal loan. Even though you technically have $200,000 of home equity in this scenario, you can’t borrow the full amount because you have to leave that 20% cushion intact. So your maximum home equity loan amount is closer to $120,000.
You may be able to find lenders who will allow you to borrow more than 80% of your capital. But they are relatively rare – more so than for home equity lines of credit (HELOC). Also note that VA loan borrowers can often borrow up to 100% of their equity.
Credit Score Requirements for Home Equity Loans
For some lenders, a FICO score of 650 is the threshold for home equity loans. But many allow credit scores starting at 620. Below that, your search will become more difficult.
As with all types of loans, the higher your credit score, the cheaper your home equity loan should be. If your score is above 740, you’ll likely get the lowest interest rate available, all things being equal. If it’s over 700, you’re almost certain to get approved and get a very attractive rate. If your score is above 600, your application will not necessarily be refused. But you’ll probably pay a slightly higher rate.
Home equity loan income requirements
As with any type of home loan, you need a stable income and employment history to qualify for a home equity loan. Lenders want to know that you will be able to afford the ongoing monthly payments.
There is no fixed formula for how a lot you must win to be approved for a home equity loan. However, your lender will carefully review your finances to ensure that you can comfortably pay your new loan repayments. To do this, it will calculate your debt to income ratio. The less you spend on monthly debt relative to your income, the more approval you can get to borrow on a home equity loan.
Debt ratio for a home equity loan
Your debt-to-income ratio (DTI) is the proportion of your gross monthly income (before taxes) that is allocated to regular monthly debt payments.
Your scheduled home equity loan payment will be added to your current mortgage and other debts when a lender calculates your DTI to see if you qualify. Lenders love to see DTIs below 36% and will often reward you with a better rate if yours is that low. But many will approve requests with DTIs of up to 43%.
Payments that count towards your DTI include:
- Housing costs, including mortgage, property taxes, home insurance, and homeowners association fees (if applicable)
- Your new home equity loan payment
- Debt payments, including minimum payments on credit cards and standard monthly payments on your installment loans (personal, car, student loans, etc.)
- Child support and alimony plus any other court-ordered payments
Your DTI does not include expenses that vary each month, such as food, utilities, gas, cell phone subscriptions, etc.
You can calculate your DTI by adding your monthly obligations, dividing them by your gross monthly income and multiplying by 100. Here is an example: your monthly obligations are $1,500. And your pre-tax income is $4,000. $1,500 ÷ $4,000 = 0.375 x 100 = 37.5. Your DTI is 37.5%. The Consumer Financial Protection Bureau also has a DTI calculator you can use.
What information is needed for a home loan?
A home equity loan is a type of mortgage, and you can expect an application process similar to the one you went through when you took out your original mortgage. You will be asked to show standard financial documentation, including:
- Your last two payslips
- Current statement of your existing mortgage, showing balance and mortgage payments
- Tax documents for the last two years: W2 for employees or 1040 for the self-employed and those who work on commission
- Current and most recent statements of your bank accounts, pension plans and investment accounts
- Home insurance statement
- Divorce decree, if any, as well as any court orders regarding child support and alimony
- Award letter or proof of continued receipt of the Social Security benefits and pensions you receive
If you have bumps on your credit report, you can also provide a letter of explanation explaining why they happened and reassuring the lender that you have recovered from previous credit issues.
Can you be refused a home equity loan?
Unfortunately, some applicants are denied their home equity loans. Don’t panic if you are one of them. Try to find a different lender who is more sensitive to your situation. Some are more flexible than others.
If your application is denied, it’s likely because you don’t meet lenders’ requirements for a home loan in one of these areas:
- Own funds available: You usually need more than 20% equity to qualify for a home equity loan
- Credit score: Few lenders will approve you if your score is below 620. But many will approve you above
- DTI: If your DTI, including future home equity loan payment, is over 43%, you may have trouble getting approved
These are typical home equity loan requirements. But it’s a competitive market. And you may be able to find a lender who will help you if you don’t meet all three criteria.
Find out if you qualify for a home equity loan
If you meet the basic thresholds for available equity, credit score, and DTI, there’s a very good chance you can get approved for a home equity loan. But you won’t know for sure until you apply with a lender.
Keep in mind that the mortgage market is competitive. You can often find a lower interest rate and/or easier approval standards by shopping around. So don’t hesitate to get quotes from several home equity lenders and compare their offers.
The information contained on The Mortgage Reports website is provided for informational purposes only and does not constitute advertising for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent company or affiliates.