Home equity loan requirements
Owning a home is the first step to building home equity
If the value of your home is greater than your mortgage balance, you have home equity. And if you have at least 15% home equity available, you may be able to take out a loan on your home to consolidate debt, fund home improvement projects and more.
Find out if you qualify for a home equity loan and how to calculate your current home equity.
Key insights:
- Home equity loans are paid out as one lump sum.
- Lenders require homeowners to have good credit and low debt-to-income (DTI) ratios to qualify.
- Home equity loans can come with 2% to 5% closing costs.
What is a home equity loan?
A home equity loan, sometimes referred to as a second mortgage, is a loan that allows homeowners to tap into the available equity in their homes to use for pretty much any purpose.
“One of the best uses of a home equity loan is reinvesting in your home by doing renovation projects,” said Santa Barbara Realtor Maureen McDermut from Sotheby's International. “Upgrading your kitchen or adding an addition to your home can help increase its value further and help you when you go to sell."
McDermut also recommends using a home equity loan to consolidate or pay off high-interest debt and pay for education expenses, which will reduce your reliance on student loans.
To get a home equity loan, you follow the same application process as other loans, although this one may come with a required home appraisal to determine how much equity you can utilize.
Once approved, your funds will be paid out to you as one lump sum, similar to a personal loan. Home equity loans come with a fixed interest rate, so you’ll have the same monthly payment and won’t have to worry about a fluctuating or adjustable rate.
If you are unsure how much equity you want to borrow, consider applying for a home equity line of credit (HELOC) instead. This way you can tap into equity (up to a limit) when you need it without applying for an additional loan.
Home equity loans vs. cash-out refinance
Both home equity loans and cash-out refinancing allow homeowners to tap into the equity in their homes. However, while a home equity loan is taken on in addition to your original mortgage, a cash-out refinance loan replaces your existing mortgage with a larger one. It allows you to take the difference between the new mortgage balance and old mortgage balance in cash and use it as you wish.
» MORE: How to use home equity
Qualifications for a home equity loan
Each lender will have its own set of requirements for a home equity loan, but here are some qualification guidelines for applying:
- A credit score of 620 or higher
- Many lenders might set their minimum credit score at 620, but the higher your score, the better your chances are for approval and a low interest rate.
- 15% to 20% equity in your home
- Most lenders will require you to have at least 15% equity, though some require as much as 20%. Part of this calculation is the loan-to-value (LTV) ratio – how much you owe versus the current market value of your home.
- Low debt-to-income (DTI) ratio
- Many lenders cap the debt-to-income ratio at 43% for home equity loans with fixed rates and terms, and most lenders require a DTI ratio of no more than 36% for good rates.
- Income verification
- Lenders want to see that you have the ability to repay a second loan without financial strain. Income requirements will vary depending on how much equity you have and the amount of the loan that you’re trying to secure.
How to calculate home equity
Your lender will require a home appraisal before telling you how much equity you can access and your rates. You can calculate how much home equity you potentially have before applying by:
- Estimating your property value
You can use an online real estate listing site like Zillow to get an idea of how much your home is worth. You can further estimate your home value by seeing how much similar homes in your neighborhood sold for. Note that this number might not be accurate and should be used for a rough estimate only. - Subtracting your balance
Once you know your home’s estimated value, subtract how much you still owe on your mortgage loan. If you own more than 15% to 20% of the estimated value, you can move forward with the application.
After you apply for a home equity loan, your lender will send a third-party appraiser to your home to determine your property value. Professional appraisals can cost up to $500, and you will likely be responsible for paying.
How much equity can I borrow?
Most of the time, a bank will lend between 80% to 85% of your home’s equity. You cannot borrow 100% of your equity. Also, you don’t need to borrow against the full amount of available equity in your home; you can opt to borrow a smaller amount instead.
Be careful that you don’t borrow more money — and use up more of your equity — than you think you’ll need. You want to make sure you can pay back the loan, since you’re using your home as collateral. If you can’t pay it back, you risk losing your home. Additionally, keep in mind your home price may decrease, causing the equity in your home to decrease, and you could wind up upside down on your mortgage.
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FAQ
How long are home equity loans?
Lenders offer different repayment periods on home equity loans. Typically these loans range between five to 20 years. Since home equity loans have fixed rates, the amount you pay every month will always be the same.
Are there closing costs on a home equity loan?
You should expect to pay 2% to 5% of the loan amount 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 vary by lender, so compare costs before choosing a company.
Can you have two home equity loans?
Technically, if you have enough equity and meet the lender’s qualifications, you can have more than one home equity loan. Be aware that applying for another loan will come with additional fees.
Bottom line
Home equity loans are a good choice if you need funds to do renovations or pay off credit card debts. Qualifying for a home equity loan is similar to qualifying for a mortgage. You need a good credit score, an LTV ratio of less than 80% to 85% and a DTI ratio below 43%. A lender will also evaluate your payment and credit history to determine how likely you are to pay the loan back.
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