Owning a home gives you security, and you can borrow against your home equity! A home equity loan is a type of loan that allows you to use your home’s worth as collateral. However, you can only borrow using home equity if enough equity is available to you.
Equity is the difference between the value of your home and what you owe on the mortgage. To build equity, pay the mortgage and invest in home improvements projects. The loan requirements vary by lender, but there are standard requirements. Let’s discuss some of these requirements.
What Are the Requirements for a Home Equity Loan?
The qualification requirements for home equity loans vary with lenders, but generally, you will need the following to get approved:
1. At Least 15% Equity in Your Home
To borrow from the equity of your home, most lenders require you to have paid at least 15%-20% of your home’s value. For example, if your home is valued at $500, 000, you should have paid down at least $75,000. To get the math right, your lender will appraise your home at your cost.
Also, the lenders set your borrowing limit using your loan to value ratio. LVT is calculated by dividing your mortgage loan balance by the current value of your home. Assuming the figures above, your LVT will be $425,000/$500,000 to get 0.85%. With the LVT ratio at 85%, you have 15% equity in your home.
Lenders will loan you an amount not more than 85% of your combined loan value limit. This means that the sum of your loan and the mortgage balance should be less than 85% of the value of your home. Using the figures above, 85% of the home’s value is $425,000. Having only paid $75,000, your loan balance is $425,000, equal to 85% of your home’s value, and therefore, you are not eligible for a home equity loan.
2. Good Credit Score
Like other types of loans, a good credit score is required to approve your home equity loan. Most lenders require homeowners to have a credit score in the mid-600s. With a higher credit score of 750 and above, you stand a better chance of high loan amounts and lower interest rates. However, you must meet all the requirements in step one above.
Also, some lenders consider homeowners with a credit score below 600, but you must have more home equity and less debt than your income.
If you have a bad credit score, you might consider improving it or foregoing the home equity loan since you will get lower loan amounts with higher interest rates.
To improve your credit score, pay your loans and credit cards on time, make plans to clear as much debt, and do not apply for new credit cards within that period.
3. A Debt-to-Income Ratio of 43% Or Less
The debt to income ratio is the percentage of your monthly income taken up by debts, and it also plays a role in reviewing your home equity loan application. The qualifying ratio differs with lenders, but most require you to have a DTI ratio of less than 43%.
Your DTI equals the sum of all your monthly expenses, including mortgage loans, student loans, insurance, child support, taxes, and any other debt, then divide the total by your gross monthly income.
If you are considering a home equity loan, calculate your debt-income ratio before approaching the bank. If it is above the 43% ratio, pay off as much debt before applying. Also, you can consider extending the repayment period of your loans to reduce monthly installments, but beware that this will mean paying more interest in the long run.
4. Income Requirements
Your lender will look at your income to ensure that you have sufficient income to repay the loan. They will also ask for documents to prove your sources of income. Your total monthly income will also be used to determine your loan limit.
5. Consist and On-Time Bill Payment
No one wants to lend to an unreliable and risky borrower. To determine the type of borrower you are, your lender will look into your payment history. If you have been paying your debts consistently and on time, you are likely to do the same on the home equity loan, and therefore they will consider your application.
What Is the Maximum Amount You Can Borrow on a Home Equity Loan?
The maximum amount you can borrow as a home equity loan is limited to a combined loan-to-value ratio of 85%. This means that the sum of both loans, that is, the mortgage loan balance and desired loan, should not be more than 85% of the value of your home.
What Percentage Can You Borrow on a Home Equity Loan?
Most home equity lenders allow you to borrow 80-85% of your home’s equity, minus the mortgage balance. Therefore, you need 15-20% equity to qualify for a home equity loan.
To build your home equity, pay down your mortgage. You can speed up the process by paying more than the minimum monthly installments. Also, make home improvements through renovations that improve its value.
However, the actual amount you will get depends on other factors like your credit score, income, debt repayment history, and debt to income ratio.
How Long Do You Have to Wait to Get a Home Equity Loan?
A home equity loan takes 30-45 days to process. The waiting period is the time underwriters take to process your application and ensure that you qualify for the loan. They will look at your credit score, calculate the debt-income ratio, and look at your payment history, among other processes, to confirm that you meet their lending requirements.
What Credit Score Do You Need for a Home Equity Loan?
Most lenders require you to have a credit score of at least 620 to qualify for a Home Equity Loan. However, you will get a higher loan amount and reduced interest rates with a credit score of 700 and above. Therefore, before applying for the loan, work towards improving your credit score.