- When you apply for a home equity loan, you need home equity, proof of income, and a decent credit score.
- Most lenders will lend against 80% to 90% of the property value.
- You may also need a property appraisal.
To borrow with a home equity loan, you must meet a lender’s home equity loan requirements – minimum credit scores, a healthy debt-to-income ratio, and sufficient home equity. In addition to completing a loan application, you’ll probably have to supply proof of income, authorize a credit report, and pay for a home appraisal. You’ll also have to pay closing costs. Here is what you can expect when you apply for a home equity loan.
Understanding Home Equity Loans
Also often known as a second mortgage, a home equity loan permits you to borrow money using the equity you’ve accrued in your home as collateral. You will pay back this loan in monthly installments.
The process involved with getting a home equity loan is similar to a standard mortgage. You apply for a home equity loan from a participating lender or bank. Underwriters make sure you mean the lender’s home equity loan requirements, and you sign a final set of documents and close the loan. Lenders disburse home equity loan funds in a single lump sum after closing.
“The loan is secured by your home and can be used to consolidate secured and unsecured debt or to fund significant purchases like home improvements or to buy an automobile. Some people also use it to pay for higher education tuition,” says Rocklin, California-based Lyle Solomon, a financial expert and attorney.
Home equity loan interest rates are usually fixed, making your monthly charges consistent and predictable.
What Do Most Lenders Require for a Home Equity Loan?
Curious about how to qualify for a home equity loan? Good candidates for pursuing this financing meet home equity loan requirements for eligibility. You’ll need a good credit score, sufficient equity built up in your property, and a favorable debt-to-income ratio.
“You need to have good credit to qualify for a home equity loan. Most lenders require borrowers to have at least a 620 credit score. If you have bad credit or below 620, your options for a home equity loan become fewer,” says Ahren Tiller, founder/supervising attorney at Bankruptcy Law Center in San Diego.
“A FICO score of 680 or higher will almost certainly qualify you for a home equity loan,” adds Solomon. “Having a good credit score will help you get better interest rates, saving you a lot of money. Plus, a higher score increases your chances of approval.”
You must calculate your debt-to-income (DTI) ratio when seeing how to qualify for a home equity loan. DTI is the relationship between your income and your monthly debt payments. You calculate your DTI by dividing your total monthly payments for accounts like mortgages, auto loans, credit card balances, and student loans (not living expenses like utilities or food) by your gross (before tax) monthly income.
Your DTI must meet lender guidelines. For most, that means a DTI not exceeding 43%. When you apply for a home equity loan, your DTI should incorporate its estimated payment. And if you plan to use that home equity loan to pay off debt, you won’t need to factor those bills into your DTI calculation because you’ll have paid off those accounts.
“The qualifying DTI percentages will differ from one lender to the next. Some lenders require a DTI of less than 36%, while others may be ready to go as high as 43% or 50%,” explains Solomon.
How Much Can You Borrow With a Home Equity Loan?
Mortgage lenders qualify you with a loan-to-value (LTV) calculation when you apply for a home equity loan. Most home equity lenders set their maximum LTV between 80% and 90%. That means your total loan balances (including your prospective home equity loan) can’t exceed 80% to 90% of your home’s current value.
“Having at least 20% equity is one way to guarantee that your loan application will be granted easily,” says Christopher Liew, a chartered financial analyst and founder of Wealthawesome.com.
You can then borrow as much as 80% of the value of your home instantly with a reduction equivalent to the amount of your remaining mortgage loan balance, respectively.”
How can you calculate your maximum loan amount?
- First, estimate your home’s current value.
- Next, multiply that number by your lender’s maximum LTV. If you have not selected a lender, multiply your home value by .8. .85 and .9. So you’ll know how much you can borrow at a maximum 80%, 85% or 90% LTV.
- Subtract your current mortgage balance from the maximum. The difference is your maximum home equity loan amount.
Suppose that your property value is $400,000, and you currently owe $325,000 on your first mortgage. So your maximum total financing is as follows:
- 80% LTV: $320,000
- 85% LTV: $340,000
- 90% LTV: $360,000
And here’s your maximum loan amount for a home equity loan (before loan costs):
- 80% LTV: $5,000
- 85% LTV: $15,000
- 90% LTV: $35,000
Note that for higher LTV loans, you’ll need to be highly qualified with a low DTI and high credit score.
How to Estimate Your Home Equity
Remember: You need to have earned sufficient equity in your home to qualify for a home equity loan. That’s why it’s wise to determine this number before applying.
Rhett Roberts, CEO/product director for Farmington, Utah-headquartered LoanPro, says the best way to determine your home’s equity is to pay for a professional appraisal. However, that’s expensive and time-consuming.
“Or, you can get a comparative market analysis from a Realtor or real estate agent. They are free and will tell you a good estimate of what your home could sell for in current market conditions,” Roberts explains.
The easiest way for most homeowners to estimate their property value is to check out several automated valuation models (AVMs) at real estate sites like Zillow, Realtor.com, or Trulia. Input your address, and you’ll get a value or range of values.
Alternatively, Roberts notes that you can ask your chosen lender or bank for a quick estimate of your home’s current home equity.
“They can do these calculations much more quickly than you can.”
How to Apply for a Home Equity Loan
Before shopping for and applying for a home equity loan, take the time to prep properly.
“First, perform a financial audit,” recommends Solomon. “Take a personal financial inventory to ensure you satisfy the loan eligibility criteria and can repay any money you want to borrow. Next, determine how much equity you have in your home and decide how much money you’d like to borrow.”
In addition, think about how much you can afford to repay every month. Home equity loans come with 10, 15, 20, and 30-year repayment terms. You can use a mortgage calculator to determine how much your monthly payment will be.
Then, collect all essential financial documents you’ll need to submit during and after the loan application process. Solomon advises gathering the following:
- Your Social Security number
- Unreported debts or support obligations, such as alimony and child support
- Record of two years of previous work experience, as well as the contact details for your last employer
- Proof of income for the previous two years
- A copy of your most recent pay stub
- Your mortgage statement
- Records of any debts and/or liens on your home
- Fair market value estimate of your home
- Proof of ownership and homeowners insurance declarations
- Title ownership documents
When it’s time to apply for a home equity loan, shop around and get rate quotes from different financial institutions. Many online and brick-and-mortar lenders, banks, and credit unions offer home equity loans.
“Shop for the best home equity loan interest rates and offers and submit your applications online,” Solomon says. “Community banks and credit unions may be more flexible than big banks regarding underwriting rules, especially if you are an existing customer. And because online lenders have lower overhead costs than traditional banks, they may pass those savings on to their customers in the form of lower interest rates and fees.”
What Are Home Equity Loan Closing Costs?
Home equity requirements also include money for closing costs. These costs can equal 0% to 5% of your entire loan amount. Per Solomon, common closing cost fees include:
- Credit report fee – $17-$75
- Flood certification fee – $10-$20
- Appraisal fee – $475-$1,000
- Tax service fee – $85-$100
- Processing and underwriting fees – $200-$500
- Title search fee – $1,000-$1,500
- Settlement fee – $150-$750
- Recording fee – $150-$300
- Appraisal review – $150-$350
- Application fee – $0-$500
Closing costs vary widely among home equity lenders, from zero to scary.
Other Things to Remember
You can improve your chances of getting approved for a home equity loan by working to improve your credit score, home equity, and DTI.
“Before applying, take action to pull up your credit score. Making timely payments on loans or credit cards, paying off as much debt as feasible, and avoiding new credit card applications can help matters,” says Solomon.
Also, if your DTI is higher than your lender’s threshold, pay down debt before applying. Or plan to use some of the loan proceeds to get rid of some bills.