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Home equity loan requirements

Owning a home is the first step to building home equity

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Written by Michele Lerner
neighborhood homes

Do I qualify for a home equity loan?

If the value of your home is greater than your mortgage balance, congratulations—you have home equity. Lenders also consider your debt-to-income ratio, credit history and other factors to determine your creditworthiness before you can qualify for a home equity loan or line of credit. After you understand what a home equity loan is and how it works, you’ll need to determine if you meet the requirements for a home equity loan.

How to qualify for a home equity loan

Follow these steps to determine if you're eligible for a home equity loan:

  1. Find out your home's market value
    Your home's market value is simply what your home is worth today. Often the value of a home will be different today than what you paid for it, especially if you live in a gentrifying neighborhood. You can improve your home market value by making smart, affordable renovations to your home before you apply for a home equity loan.
  2. Calculate the equity in your home
    The amount of home equity you have is equal to the difference between your current home market value and the balance of your mortgage. Most lenders will require you have at least 15 percent equity in your home, though some require as much as 20 percent. You can think of home equity as the part of the home you actually own.
  3. Meet income requirements
    Home equity loan income requirements will vary depending on how much equity you have and the amount of the loan that you’re trying to secure. Regardless, you will be required to provide income verification before you are approved for a home equity loan or a home equity line of credit (HELOC).
  4. Calculate your loan-to-value ratio
    Banks use your loan-to-value ratio to describe how much you currently owe on your mortgage compared to the current value of your home. Most lenders will approve you for a home equity loan with a loan-to-value ratio up to 80 percent, or slightly higher for a HELOC.

    To calculate your current loan-to-value ratio, simply divide your current loan balance by your current appraisal value, then move the decimal point over two places to convert to a percentage. For example, if you currently owe $80,000 on a house that’s worth $200,000 today, your home equity loan-to-value ratio is 40 percent.

  5. Calculate your debt-to-income ratio
    Federal regulations cap the debt-to-income ratio at 43 percent for home equity loans with fixed rates and terms, and most lenders require a debt-to-income ratio of no more than 36 percent to get good rates. You may be able to get an adjustable-rate home equity line of credit with a debt-to-income ratio up to 50 percent. You can lower your debt-to-income ratio by paying more debt off before you apply for a home equity loan.

    To figure out your debt-to-income ratio, you first need to add up all of your financial obligations per month. Be sure to include your mortgage and any loans or leases you’re still paying on, plus alimony, child support and anything else you make monthly payments toward. Next, divide your total monthly financial obligations by your monthly income, and then move the decimal over two places to get a percentage. For example, if your monthly debt payments total $2,000 and you make $5,000 per month, then your home equity debt-to-income ratio is 40 percent.

  6. Check your credit score
    The minimum credit score for a home equity loan is about 620, so if your credit score is lower than that you probably won’t qualify for a home equity loan at all. If your credit score is between 621–759, you’ll likely be able to qualify, but you may not get the best rates. You’ll need a credit score of at least 760 to get the best rate on a home equity loan.
  7. Review your credit history
    Before approving you for a home equity loan, banks and lenders will evaluate the types of credit accounts you’ve opened or closed in the past, your payment history and whether or not you have any outstanding balances in collections. Even if you have an 800+ credit score, you might not get the best rate on a home equity loan (HELOC) if you have a relatively high amount of outstanding credit.
  8. Determine your ability to repay the loan
    All of the above factors are really just ways for lenders to try to predict how likely you are to repay your loan. Your credit history, assets, employment, income, debts and balances will be scrutinized before you get approved.

How to calculate home equity

To calculate how much home equity you potentially have, subtract the liens against your house from its current value:

  1. Find your house’s real property value
    What your home’s worth now could be different than the amount you paid for it. To figure out how much home equity you have, you’ll need a current estimate of your house’s worth. You can contact a real estate agent or hire a professional appraiser to find out how much your house is currently worth. A professional appraisal can cost you up to $500 out of pocket.
  2. Subtract your balance
    Once you know the most up-to-date value of your house, subtract the amount you still owe on your mortgage from that number. This number represents how much of your house you own, also known as your home equity. You’ll need to own at least 15–20 percent of your house before you can borrow against it.

Most of the time, a bank will lend up to 80 percent of your home’s equity. Let’s say your house is worth $250,000 and you owe $100,000 on your mortgage. You have $150,000 in home equity, 80 percent of which is $120,000. Sometimes there will be a minimum amount you can borrow, usually between $10,000–$25,000. It’s important to remember that different lenders will offer you different rates. Be sure to thoroughly compare the best home equity loans before you make a decision.

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  • Max. DTI ratio: 50%
  • Max. LTV ratio: 80%
  • Lender fee: $995
  • Closing cost: 2–6%
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  • Lender fee: $0
  • Closing cost: 0–5%
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  • Max. DTI ratio: 50%
  • Max. LTV ratio: 80%
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  • Closing cost: 2–5%

Home equity loan questions

Can you use a home equity loan for anything?
You can use a home equity loan for just about anything, but that doesn’t mean you should. Most people tap into their home equity to pay for house renovations or improvements, but you could use the loan or line of credit for anything from college tuition costs, travel and other large purchases to debt consolidations and securing your retirement portfolio.

Remember that it’s important to make informed decisions with your equity. (It would almost never be in your best interest to purchase a luxury sports car with a home equity loan, for example.) The most responsible and productive ways to spend home equity funds include:

  • Improvements and renovations that will add value to your house
  • Large emergency expenses, like dealing with a job loss or major medical bills
  • Paying off or consolidating high-interest debt
  • Investing in other properties

How much can you borrow on a home equity loan?
The amount you’ll be able to borrow on a home equity loan will depend on how much equity you have and whether or not you can get approved. Subtract your mortgage balance from how much your home is currently worth to figure out your maximum potential home equity. Keep in mind that even if you’re approved, most lenders will only allow you to borrow up to 80 percent of your total home equity.

How long are home equity loans?
When you take out a home equity loan, you sign a contract promising to make payments on the principal and interest of the loan every month for a period of five, 10 or 15 years. Since home equity loans have fixed rates, the amount you pay every month will always be the same.

When deciding your ideal home equity loan length, remember that opting for a 10- or 15-year home equity loan term will spread the payments out over more time, which will lower your monthly repayment bill. A five-year home equity loan term might be best for you if you’re borrowing a relatively small amount and aren’t worried about the extra monthly expense.

Are there closing costs on a home equity loan?
You should expect to pay 2–5 percent of the loan in home equity loan closing costs. Closing costs cover the appraisal fee, origination fee, notary, title search, attorney fees, paperwork filing and sometimes other property evaluations or certificates.

Closing costs are not set in stone. For example, if your total home equity loan if $80,000, your closing cost could be anywhere from $800–$4,000 depending on your lender. This is why it’s so important to compare all your options before you decide on a home equity loan lender.

Bottom line: Should I get a home equity loan?

To qualify for a home equity loan with the best rates you’ll need a relatively high credit score, a loan-to-value ratio of less than 80 percent and a debt-to-income ratio below 43 percent. A lender will also evaluate your payment and credit history to determine how likely you are to pay the loan back.

If you qualify for a home equity loan, you can make renovations, pay off credit card debts and more. But, if you default on the loan then you will lose your house. Since the stakes are so high, it isn’t necessarily in your best interest to take out the maximum amount available to you.

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