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 that meet 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.
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 and home equity loans are tax-deductible if the funds are used to improve your home or buy real estate.
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. You can adjust the loan terms to minimize the likelihood of falling behind—a lengthier loan term results in lower 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.
You don’t have to use home equity loans to improve your home. Some people tap into their equity to go on a vacation or cover an emergency expense.
Common Home Equity Loan Requirements
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. These are some of the things a lender will review before giving you a second mortgage.
You will have to provide a valid photo ID, Social Security Number, and proof of address. This information allows creditors to verify who you are to ensure your identity isn’t being stolen.
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.
You can actively equity with each monthly mortgage payment and the down payment you put into your property. If your home value increases over time, you will have more home equity available.
Lenders set limits to the combined loan-to-value ratio of your primary mortgage and home equity loan. Some lenders set this limit at 80%, while others offer enough flexibility for a 95% LTV ratio.
If your house is worth $500,000 and your lender has an 80% LTV ratio limit, you can only borrow $400,000 against the home. If you already have a $350,000 mortgage balance, then you can only borrow an additional $50,000 as a home equity 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.
Some lenders accommodate borrowers with low credit scores. However, you will end up with a higher interest rate. If you have a lower credit score, the creditor may expect a higher down payment.
Waiting a few months to access home equity so you can raise your score can make it more affordable. You can end up with lower fees, a higher lump-sum payment, and a lower fixed rate. Not everyone can wait, but you may want to consider adding a few points to your credit score before applying if you have that flexibility.
Debt to Income Ratio Requirements
A debt-to-income 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. Refinancing and consolidating debt can also make your DTI ratio more attractive to banks, credit unions, and online lenders. Refinancing debt can reduce the monthly payments, which will lower your debt ratio.
Increasing your monthly income with a side hustle, career change, or raise from your current employer will also improve your ratio. Improving your DTI ratio will increase your chances of getting other financial products like personal loans.
Your income should be high enough to meet the lender’s DTI requirements. A higher monthly income gives you more flexibility in how much home equity you can access.
Creditors will review your bank account statements and tax returns to gauge if your income is consistent. Making a higher down payment and having a good credit score can reduce the income requirement.
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.
Catching up on any late payments and making on-time payments moving forward will improve your chances of getting approved. Keeping a close watch over your budget and trimming unnecessary expenses can alleviate some obstacles toward a good payment history. A debt consolidation loan can help you pay off any credit card debt to strengthen your payment history. Then, it’s up to you to make on-time payments for the debt consolidation loan.
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.
Financial institutions typically offer the best rates but have lengthy application processes. It can take over a week to receive funds from a traditional bank. You can also find competitive rates and terms from online lenders. Some online banks have better rates than traditional banks. Online financing companies also have quicker application processes. Some lenders give you a decision within 24 hours.
It’s best to shop around and compare home equity loan rates from several lenders before making a decision. Most creditors will run a hard credit check when reviewing your finances. A hard credit check will temporarily reduce your credit score. However, each hard credit inquiry over a 14-45 day span only counts as one hard credit inquiry for scoring purposes. Applying for several loans within a short timeframe is a good way to discover lower rates and get enough equity out of your home.
One option to consider is CrossCountry Mortgage, a trusted mortgage lender that offers a variety of home equity loan options tailored to meet your specific financial needs. CrossCountry Mortgage provides HELOCs for individuals looking to access equity in their homes, allowing borrowers to borrow up to 80% to 85% of their home’s value. By choosing CrossCountry Mortgage for your home equity loan needs, you can trust that you will receive expert advice and support from their dedicated team of loan officers. Contact CrossCountry Mortgage today to learn more about their mortgage options and start your journey towards financial freedom.
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 are 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.