Looking to substantially remodel your home? Want to install a pool or tennis court? Thinking about consolidating your debt? If the answer to any of these questions is yes, a home equity loan or home equity line of credit (HELOC) may offer a lower-interest way to do so.
Take a look at the standard HELOC and home equity loan requirements to learn what it takes to get approved and how to create a strong application.
Key Takeaways:
- When determining eligibility for a home equity loan or HELOC, lenders will look at your credit score, debt-to-income ratio (DTI) and loan-to-value ratio (LTV).
- Both options allow you to borrow against your equity. HELOCs are revolving credit lines, whereas home equity loans provide a lump sum that you pay in installments.
- You can strengthen your application by building equity, improving your credit score, reducing your debt and demonstrating stable income.
Overview Of Home Equity Loans And HELOCs
You may have heard a friend or neighbor talk about getting a second mortgage to finance a home improvement project, pool or other major expense. Generally, second mortgages fall into two main categories:
Both of these options allow you to use your home equity, but they have a few key differences you should be aware of.
Home equity loans work somewhat like primary mortgages (or even personal loans). Here’s what to expect if you get a home equity loan:
- You receive the full loan amount up front.
- You follow a fixed payment schedule over a preset loan term.
- There’s usually a fixed interest rate.
Because a home equity loan grants you immediate access to significant funds, this option may be appropriate when you have a large, one-time expense.
For example, since home equity loans are a type of collateral loan, they often come with much lower interest rates than unsecured loans and other kinds of unsecured debt. As a result, many people take out home equity loans to consolidate debt. A home equity loan can also be a cost-effective way to finance a major home renovation, such as a pool or an addition.
A HELOC, on the other hand, is a revolving line of credit with a variable rate. Here’s what you can expect if you take one out:
- You can take out what you need (up to a set limit) during a draw period.
- You may also make payments and re-borrow during this time.
- They usually have variable interest rates.
- You may no longer borrow once the repayment period starts.
The draw period and repayment period are worth focusing on because they set HELOCs apart from many other lines of credit.
When you first open your HELOC, you start the draw period. This is when you can access funds from the credit line (up to your credit limit). Draw periods usually last 5 – 10 years. In many cases, you’re required to pay just the interest during this time.
Once the repayment period begins, you may no longer access the credit line. You must also start paying toward your outstanding balance (interest and principal) each month. The repayment period usually lasts 10 – 20 years.
A HELOC can be useful if you anticipate having to fund ongoing expenses. For example, if you’ve recently purchased a fixer-upper home and want to work on it gradually, a HELOC might be a better choice than a home equity loan.
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Comparison Chart: Home Equity Loan Vs. HELOC Qualification Requirements
Comparison Chart: Home Equity Loan Vs. HELOC Qualification Requirements
| Qualification | Home Equity Loan | HELOC |
|---|---|---|
| Minimum Credit Score | At least 680 | At least 620 |
| DTI Ratio Limit | 43% or less | 43% or less |
| Required Home Equity/LTV | At least 15% – 20% equity (maximum LTV of 80% – 85%) | At least 15% – 20% equity (maximum LTV of 80% – 85%) |
| Income/Employment | Steady income that’s enough to cover payments | Steady income that’s enough to cover payments |
Home Equity Loan Vs. HELOC: Key Qualification Requirements
If you’ve decided that you want a second mortgage, your next step is to choose between a home equity loan and a HELOC. While HELOC and home equity loan requirements are fairly similar, there are a few differences you should know about. Here’s a closer look.
Credit Score Requirements
Most lenders’ HELOC requirements state that you must have a credit score of at least 620. If you have a higher score, you’re more likely to qualify for better interest rates and other loan terms. Some lenders may be willing to give you a HELOC if you have a lower score, but your borrowing costs will likely be much higher.
If you’re trying to get a home equity loan, you’ll generally need a credit score of at least 680. Keep in mind that higher scores almost always translate to better loan terms. If you’re planning ahead, it’s worth making the effort to build a positive credit history before applying.
Debt-To-Income Ratio (DTI)
Your debt-to-income ratio (DTI) is the ratio of your monthly debt payments to your monthly income. Whether you’re applying for a HELOC or a home equity loan, lenders will want to see your DTI to determine whether you’ll be able to comfortably afford monthly payments. For both HELOCs and home equity loans, lenders usually want to see a DTI of no more than 43%.
It’s easier to calculate your DTI than you might think. First, add up the minimum debt payments you owe each month. These include your mortgage, credit card payments, car loans and student loans.
Next, divide that amount by your monthly income, then multiply by 100 to make it a percentage. For example, if your payments total $2,000 and you make $7,000 per month, your DTI is about 29%.
Home Equity And Loan-To-Value Ratio (LTV)
One of the most important HELOC and home equity loan qualifications is the amount of equity you have in your home. It takes time to build equity unless you’ve put down a significant amount (like 50%) when you purchased the home. Typically, lenders want to ensure that home purchasers have kept their loan in good standing for at least 30-90 days prior to applying for a new loan. This means you can’t just get a mortgage, buy a house and instantly get approved for a home equity loan or HELOC.
Your home equity is the portion of your home you own outright. Your loan-to-value ratio (LTV) is the amount of your mortgage you have remaining relative to your home’s value.
Here’s how to calculate your home equity and LTV ratio:
- Determine your home’s appraised value (real estate listing sites can provide a good estimate).
- Determine the balance remaining on your mortgage.
- Divide your remaining mortgage balance by your home’s appraised value.
- Multiply by 100.
For example, imagine that your home is currently worth $400,000 and you have $300,000 remaining on your mortgage. Your LTV ratio would be 75%, which means you have 25% equity in your home.
For HELOCs and home equity loans, most lenders will want you to have at least 15% – 20% equity in your home, or an LTV of no more than 80% – 85%.
Income And Employment Verification
Lenders that offer HELOCs and home equity loans will seek to confirm that you’ll be able to repay what you owe with no issues. That means your income must be both stable and sufficient to cover your monthly payments.
In many cases, lenders will want to see at least two years of income from the same source. If your income is sufficiently high but you change jobs frequently, the lender may have doubts about your ability to remain employed.
The documents you’ll need to provide proof of income depend on the income type. Tax forms like W-2s and 1099s are often acceptable, as are tax returns.
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Steps To Improve Your Chances Of Approval
Understanding HELOC and home equity loan requirements is the first step toward getting a second mortgage that suits your needs. If you’re concerned about approval or want to get the best possible loan terms, follow these steps:
Boost Your Credit Score
There are many different strategies for building credit. Paying down debt to reduce your credit utilization, increasing your available credit and continuing to develop a history of on-time payments can all make a difference.
Reduce Your DTI
There are two main ways to reduce your DTI: paying down existing debt or increasing your income. If you can do one or both before you apply, you might be able to access better loan terms.
Increase Your Equity And Property Value
Paying more toward your mortgage increases your equity, but so does increasing your property value. Cleaning up your home’s exterior, installing smart home technology and making other improvements can bump up both measures.
Choose The Right Lender
You don’t have to accept a loan from the first lender that approves you. By taking the time to compare loan terms and choose the right mortgage lender, you can improve your chances of getting the best possible rate.
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The Bottom Line
A HELOC or home equity loan might not come with the same level of commitment as a mortgage. Because they’re still secured by your house, however, it’s critically important to make sure you can pay yours back before you accept.
Understanding the basic home equity loan qualifications is a great first step, but choosing the right lender is an important part of the process. Quicken Loans is here to help. Reach out today to get matched with verified lenders.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
