What are the Requirements For a Home Equity Loan?

Requirements to Borrow from Home Equity

It is important to realize that homeowners need to qualify for home equity loans. The lender will want to make sure the borrower will have the ability to pay the interest on the home equity loan. The lender analyzes different aspects of the homeowner’s financial life and the property itself before giving out a loan. There are a few important criteria prospective borrowers may want to be aware of before asking for a home equity loan.

Paying off at least 15 percent to 20 percent equity in your home

The 15-20% figure is generally the minimum equity a lender will accept for a home equity mortgage. Traditionally there are two options to building up equity in a home. The first is paying off a mortgage on the home. Each monthly payment will build up home equity. Of course, homeowners have the option of making a down payment above this threshold, which would give them the equity to qualify for a home equity mortgage. 

The second option is home improvements. Equity is built by increasing the difference between the market value of your home and the money you owe on it. Home improvements by the homeowner can increase the home’s value above the original mortgage amount the homeowner owes.

Have a credit score in the mid-600s

Credit scores are the main instrument that lenders look towards when evaluating a borrower. A credit score gives an overview of the borrower’s history of debt and payments. Intuitively, the borrowers that have the best history of making timely payments will typically have the highest credit scores. Getting your credit score checked would most likely be necessary before asking for a home equity loan.

Have a debt-to-income ratio of 43% or lower

Debt-to-income ratio is calculated by taking all of your monthly debt payments and dividing them by your monthly income (typically before taxes). The “magic number” for debt-to-income ratio for being accepted for a home equity loan is typically 43% or lower.

Have a sufficient income

This is a broad statement, but sufficient income will be determined by the amount of money you are looking to borrow. Proof of employment or some sort of steady stream of income is important. This allows the lender to evaluate whether the borrower will have the ability to make timely loan payments and other payments on the home.

Have a reliable payment history

A track record of being on time with payments, whether it be rent or credit card payments, will go a long way in showing the lender that the homeowner is a worthy borrower. Some younger prospective borrowers may struggle with this as they do not have the same history as their elders.

Alternatives to home equity loans

There are other ways for individuals to access debt outside of a home equity loan. Some folks might not want to be tied to the longer repayment periods home equity loans tend to have. There are pros and cons to each option, the individual’s circumstances are the best determinant for which option to choose:

HELOC

HELOC stands for a home equity line of credit. A homeowner is given a revolving line of credit by the lender. This is similar to a credit card. HELOC’s have draw periods of up to 10 years, giving the homeowner plenty of time to borrow against their home’s equity. The homeowner also has the flexibility of borrowing less than the credit limit. This is helpful if a financing need is not as large as it was originally thought to be.

A downside of a HELOC is the variable interest rate. Payments on a HELOC are not fixed, which could create some hefty payment months for homeowners if interest rates begin to rise.

Personal loans

A personal loan from a lending institution is another option for homeowners. A benefit of personal loans is that they typically have lower interest rates than a credit card. The debt-to-income ratio on a personal loan is generally at 36% or less, so this is a bit more of a stringent option than a home equity loan.

0% APR Credit Cards

Recently, credit card companies have been trying to entice borrowers with 0% APR over an extended period of time. Some cards will offer a 0% APR rate for up to 12-18 months. Of course, if your debt is not paid off in the given time period, the APR will be much higher. This offers a great short-term option for access to quick credit. However, if a borrower is not careful, they can rack up debt that is difficult to pay off. Getting access to high spending limits may also be more difficult than other lending options offer.

CD loans

A CD (stands for Certificate of Deposit) loan is a type of secured personal loan that uses a certificate of deposit as collateral. These loans tend to have lower interest rates than personal loans. CDs typically have shorter maturities, usually around one year.

Family Loans

The least personal of all the loan options. A family loan is simply a loan between family members. Loans between friends or even on the peer-to-peer market are similar ideas. Unlike interest on home equity loans, these loans have no obligation to be set at market rates. Again, the financial and personal situations of participating members are important before determining whether a family loan makes sense.

Bottom Line

These are some of the most important considerations for determining whether a home equity loan makes sense. Meeting the qualification is critical, as there are a few steps homeowners may need to take in order to secure a home equity loan.