If you’re considering a home equity loan, you want to understand how they work and what lenders require to get approved.
This guide explores how you can unlock the equity in your home to get the cash you need and if a home equity line of credit is a better fit. It also outlines the key requirements you should meet to boost your approval odds and where to start your search for a home equity loan product with competitive terms and meets your unique needs.
What is a Home Equity Loan?
A home equity loan is a debt product that allows you to tap into the equity in your home. You can use the loan proceeds to fund home improvements, refinance high-interest debts, cover costly emergencies, or however you see fit.
Home Renovation Loans
How Does a Home Equity Loan Work?
If you’re approved for a home equity loan, the loan proceeds are dispersed in a lump sum. The interest rate is fixed, and you will make fixed monthly payments over an extended period until the loan is paid in full. Most lenders offer loan terms from five to 30 years.
How Much Can You Borrow With a Home Equity Loan
The loan amount is limited to 75 percent and 85 percent of your home’s equity, minus your outstanding mortgage balance. To illustrate, if your home’s current value is $350,000 and you owe $285,000 on your mortgage, you have $65,000 in equity.
If the lender extends home equity loans of up to 75 percent, you could qualify for up to $48,750 in funding. Assuming they’re a bit more generous and allow loan values up to 85 percent, the amount you’re eligible for could increase to $55,250.
Should You Get a Home Equity Loan or HELOC?
It depends on your financial situation and how you plan to use the funds. If you need all the money upfront, a home equity loan is the better option. Otherwise, a home equity line of credit (HELOC) allows you to access funds up to the total amount you’re approved for over a draw period of 10 years. So, you’re permitted to draw what you need and can avoid overspending.
Also, know that HELOCs come with variable interest rates. So your payments could fluctuate over the life of the loan. The good news is the interest paid on HELOCs is tax-deductible if the funds are used to improve your home.
Whether you get a home equity loan or home (HELOC), your home is used as collateral. This means your property could face foreclosure if you fall behind on the monthly payments.
So, it’s essential to evaluate the benefits and drawbacks of these loan products before you make a decision. But both loan products can get you access to a large amount of cash at a far lower interest rate than you’d pay on a credit card.
If used to pay off costly debts, you could save a bundle in interest over time. (Quick note: avoid using the credit cards once they’re paid off to avoid digging an even bigger hole of debt for yourself). You can also fund home renovation projects to possibly increase the value of your home, but be mindful that the loan balance must be paid in full when you sell your home.
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Common Requirements to Get a Home Equity Loan
Before you shop for a home equity loan, knowing what lenders look for in potential applicants is ideal. These figures are general qualification criteria, but every lender has its own requirements that could be more or less stringent.
Equity Percentage Requirements
You’ll need at least 15 to 20 percent in equity to potentially qualify for a home equity loan. The lender may require an appraisal to confirm your home’s value and your eligibility for a loan.
Credit Score Requirements
It’s possible to get approved for a home equity loan with a credit score of at least 620. However, a higher credit score could help you qualify for a loan product with more favorable terms and a lower interest rate.
Debt to Income Ratio Requirements
A debt-to-income (DTI) ratio of 43 or lower is acceptable to most lenders. To calculate this figure, add up all your monthly debt payments and divide the sum by your monthly gross income. If you can pay off debts to reduce this percentage before applying, you could strengthen your approval odds.
Your income should be high enough to meet the lender’s DTI requirements.
Payment History Requirements
Lenders want reassurance that you’ll make your loan payments on time. So, they review your credit report and analyze payment history on credit card and loan amounts to confirm that you have extensive experience managing debts properly.
Where to Get a Home Equity Loan
Home equity loans are offered through several brick-and-mortar and online banks. Credit unions and direct online lenders also offer home equity loans with varying repayment terms and interest rates.
If you’re looking for a more flexible loan solution that gives you increased borrowing power, consider RenoFi. They offer innovative loan solutions to fund your next home renovation project. But what sets RenoFi apart from the competition is the ability to borrow up to 90 percent of your home’s after-renovation value to pay for your home improvements.
Even better, they partner with credit unions that pride themselves on extending some of the lowest rates on the market to qualified consumers to help you keep more of your hard-earned money in your pocket.
FAQs about home equity loan and HELOC requirements
Here are some frequently asked questions about the requirements for home equity loans and HELOCs:
There’s no right or wrong answer to this question. It depends on your financial situation and how you plan to use the funds. Conduct a cost-benefit analysis to determine if the benefits of taking out a home equity loan outweigh the costs and potential drawbacks.
Both home equity loans and HELOCs allow you to tap into your home’s equity to get the funding you need. However, home equity loan proceeds are disbursed as a lump sum, and HELOCs provide a line to draw against for a set period.
The interest rates for home equity loans is fixed, but HELOCs have variable rates. Also, you repay the entire loan amount of the home equity loan. But you only pay what you borrow from the HELOC.
It’s best to have 15 to 20 percent in equity in your home to qualify for a home equity loan or HELOC.
Most lenders require a 620 credit score to qualify for a home equity loan or HELOC. The higher your credit score, the better, as you could potentially be eligible for more competitive loan terms.