Requirements for a Home Equity Loan and HELOC
If your home is worth more than your mortgage balance, you have equity. If you’re lucky enough – or smart enough – to be in this situation, here’s how you can turn that equity into purchasing power.
Ways to unlock your home equity
The two most common ways to gain equity in your home are through a home equity loan or home equity line of credit. The loans offer a lump sum at a fixed rate of interest which is repaid over a set period of time. A HELOC is a revolving line of credit that you can draw, repay, and re-draw on for a specified period, typically a decade. This often starts with a variable interest rate followed by a fixed rate period.
A third option is a refinancing of collection, where you refinance your existing mortgage into a loan for more than you owe and pocket the difference in cash.
The requirements for borrowing against home equity vary by lender, but these standards are typical:
Equity in your home of at least 15% to 20% of its value, which is determined by an appraisal
Strong history of paying bills on time
Your debt-to-income ratio
To study your home equity loan application, lenders calculate your debt-to-income ratio to see if you can afford to borrow more than your current obligations.
To find this number, add all the monthly debt payments and other financial obligations, including the mortgage, loans and leases, and child support or alimony, then divide by your monthly income and convert this number to percentage. For example, your DTI is 40% if you earn $ 3,000 per month and make payments totaling $ 1,200.
What Debt-to-Income Ratio Do Lenders Require? For a fixed-rate, fixed-term home equity loan, federal regulations set the limit at 43% DTI.
With HELOCs, lenders have more discretion, which means you can shop around if your DTI is higher. Comerica offers home equity lines of credit with DTIs of up to 50%, says Winston McEwen, deputy banking center manager at Comerica Bank in Cupertino, Calif. Chase sets a 43% debt-to-income limit for HELOCs, according to his website.
This range of standards requires consumers to exercise good judgment. Even if you are eligible, think carefully about how much debt to take. When you borrow against the equity in your home, you are putting your home as collateral, which means the bank could take the home if you don’t pay the loan on time.
Role of credit scores
Lending strategies vary, “so what one lender might think of as a ‘good score’ another might think of them as an unprivileged lender,” says Ethan Dornhelm, vice president of score and analytics at FICO . At Comerica, for example, the minimum FICO score for home equity loans is 680, says McEwen.
Depending on your lender, borrowers with top-notch FICO scores (740-799) and super-prime scores (800 and above) may get a better deal. But not always. While some lenders use formulas that rely heavily on credit scores, others focus on the big picture. Standard Bank in Monroeville, Pa., Is looking at several factors, says CEO Timothy K. Zimmerman.
“If you have a credit score of 820 and I have a 680, that doesn’t mean you’ll get a better rate. You might have a score of 820, but you might have a lot of credit going, ”says Zimmerman.
The loan is limited
Typically, you can borrow up to 80%, and sometimes 85%, of the property’s value minus its mortgage debt, says Ron Haynie, senior vice president of mortgage finance policy at Independent Community Bankers of America. , a commercial group of banks serving communities.
Standard Bank’s Zimmerman says customers with exceptionally low DTIs can, on a case-by-case basis, sometimes borrow up to 89%.
In short, the debt to income ratio is essential. If your mortgage balance is $ 200,000 and your home is worth $ 325,000, your credit limit would be $ 60,000 if you borrow 80%.
Here’s the math: $ 325,000 x 80% = $ 260,000. Then $ 260,000 – $ 200,000 = $ 60,000 credit limit
To find out the value of your home, you will need an appraisal, which costs around $ 300 to $ 500.
Make big improvements?
See how much equity you have, what you can borrow, and compare lender refi rates all at once.
Refinancing of collection
A less popular option for accessing home equity is to refinance a new mortgage and then extract some of your equity in cash. Your interest rate in a refinancing depends on your current mortgage interest rate. Zimmerman says the borrowers he works with shy away from this type of refinancing because they would end up with a higher interest rate than what they are currently paying.