A Guide To Home Equity Loan Requirements
Do you have a large purchase coming up? Do you have equity built up in your home ready to be utilized? A home equity loan may be the perfect option for you. But what requirements do you need to have to qualify? Below, we will cover all home equity loan requirements and whether they fit your financial needs.
What Is A Home Equity Loan?
A home equity loan is a type of second mortgage that allows you to utilize the equity you’ve built up in your home to receive a lump sum loan payment. You must make monthly payments on the loan for a period of years until it is paid off.
Home equity loans are a great way for homeowners to tap into their home’s equity and turn it into cash. If you have a large payment on the horizon, such as a child’s college education or much needed home renovations, you can use a home equity loan to fund the expense.
A home equity loan is secured, meaning you provide your home’s equity as collateral for the loan. This arrangement makes the loan less risky for lenders, so they are willing to loan the money with more favorable terms than an unsecured loan. However, this also means that if you fail to make the payments, you could lose your home in foreclosure. Other types of unsecured loans, such as personal loans, offer cash without risking any collateral. But these loans are riskier for the lenders, so you will be forced to pay higher interest rates and receive a smaller amount of money than you would with a home equity loan.
Home equity is the value of your home minus the amount of money you have left to pay on its mortgage. So with each mortgage payment or each time your home increases in value, your equity increases. Before you can receive a home equity loan, you must ensure that you have enough home equity built up on your property.
Home Equity Loan Qualifications: At A Glance
The chart below shows both the general requirements from most lenders.
Home Equity Loan Requirements
Home Equity Percentage
No more than 80% – 90% of your equity
2% – 6% of the loan amount
Requirements For A Home Equity Loan, Explained
Here is an in-depth look into each of the home equity loan requirements.
Your credit score is one of the most important factors lenders consider when determining whether to offer you a home equity loan. Generally, you will need a credit score of at least 620 to receive a home equity loan from most major lenders. However, some lenders require a higher score to qualify for a home equity loan.
Your credit score represents your ability and likelihood to pay back a loan. The score takes into account several factors, such as payment history, credit utilizations, length of credit history, the amount of new credit you have and the mix of your credit sources.
The higher the score, the more likely you are to receive a loan with more favorable benefits, like lower interest rates.
Debt-To-Income Ratio (DTI)
Debt-to-Income ratio is a percentage showing how much of your monthly income you use to pay off your existing debt. This measurement is important for lenders to determine whether you have enough room in your budget to afford an additional monthly payment for a home equity loan. If you are already using the majority of your income on debt payments before taking on even more debt, you might have a hard time paying off a home equity loan. That’s why most lenders require a DTI of less than 45% to qualify for a home equity loan. That means that the amount of your monthly debt payments must be less than 45% of your total monthly income. To calculate your DTI, divide how much money you owe each month in debt by how much you earn income, before taxes.
The debt calculated in your DTI ratio is split between front-end and back-end debt. Front-end debt includes your current monthly mortgage payment, property taxes, mortgage insurance and homeowners insurance premiums. Back-end debt includes credit card debt, auto loan payments, student loans payments, and any other debt you may have accrued.
Home Equity Percentage
Lenders consider the amount of equity you have built up in your home for several reasons. First, lenders want you to build up enough equity in your home before you use it as collateral. Typically, lenders will not let you qualify for a home equity loan until you have built up at least 20% equity in your home.
Once you have accrued the necessary equity, lenders will typically not allow you to take out 100% of it through a home equity loan. Lenders want you to continue to have “skin in the game” when it comes to your home. If you were able to take out all of your equity in cash, you may not have an incentive to continue paying your mortgage because you no longer have any equity to lose. That’s why lenders typically only let you take out 80% – 90% of your home’s value.
While home buyers expect closing costs when receiving their first mortgage to purchase a home, many are surprised when a second mortgage requires similar closing fees. However, lenders and several third parties perform much of the same work for your home equity loan as they do for your first mortgage, so the closing costs for both are typically similar. That means you will pay between 2% and 6% of the loan value in closing costs for a home equity loan.
Closing costs are divided between fees for the lender and several third parties. To the lender, you must pay a mortgage origination fee to cover the costs of processing and underwriting your loan. To third parties, you must pay an appraisal fee, credit report fee, notary fee, as well as title search and insurance fees.
Home Equity Loan Pros And Cons: At A Glance
The chart below covers the benefits and downsides of home equity loans.
Lower interest rates: you will typically have lower interest rates than credit cards or personal loans.
Risking your home: If you don’t make the required monthly payments, you risk losing your home to foreclosure.
Fixed rates: home equity loans are typically fixed-rate loans, so you can plan to pay the same amount every month.
Two Mortgages: You will have to manage both mortgage payments every month.
Lump sum: you will be able to receive a large amount of money at one time for a major purchase.
Longer funding time: You still have to go through a weeks-long process to apply and qualify for a home equity loan, so it is not a good option if you need cash urgently.
Is A Home Equity Loan A Good Idea For You?
There are several scenarios in which home equity loans are a great option for you. Since you can receive a large lump sum payment, home equity loans are great for large purchases with a fixed price. One of the most common uses that fit this criteria is college tuition. Another common purchase after a home equity loan are home renovations. Since the renovations can increase the value of the home, this is a great way to restore the equity you took out of the home to get the loan. Using your loan for renovations may also give you access to significant tax benefits, including the ability to write off your interest payments on the loan.
If you have a big purchase on the horizon, timing your home equity loan can be very important. The best time to take out a loan is when you have lots of equity built up in your home and your home is as valuable as possible. While it can be hard to time the market, it may pay off to be patient by simply living in the same house for many years. If you purchase a home at the same time your child is born, you have a pretty good chance of building a significant amount of equity to pay for college with a home equity loan by the time they’re of age.
There are other options if you don’t want to go with a home equity loan, too. If you do not have enough equity in your home, can’t afford a second mortgage, or only need a small loan, a personal loan might be a better option for you. These unsecured loans have higher interest rates but a shorter approval process so you can get the money you need as soon as possible.
Below are some of the most common questions about home equity loans.
Can I get a home equity loan with bad credit?
You are unlikely to qualify for a home equity loan with bad credit. The minimum credit score that most lenders require to qualify for a home loan is 620, which is considered a “fair” credit score based on the rating system used by the major credit bureaus. If you have a “poor” credit score between 300 and 579, it will be extremely difficult to qualify. It may be wise to focus on improving your score by paying down debt and maintaining a positive credit history of no missed payments.
How long are home equity loans?
The length of home equity loans depends on the specifics of the loan terms. Typically, you have between 5 and 30 years to pay back the loan in full. Loan terms with shorter time frames will require you to pay larger monthly payments but allow you to pay less interest over the life of the loan.
How quickly can I get a home equity loan?
A home equity loan is not the best option if you need cash quickly. The application, approval and closing process typically takes between 2 to 8 weeks before you can receive your money.
The Bottom Line
Home equity loan requirements include a “fair” credit score, a DTI below 45%, a home equity percentage above 20%, and enough cash to pay closing costs between 2% and 6% of the loan’s value. If you meet these requirements, apply for a home equity loan today!