To get a home equity loan, you’ll need to qualify, which means your lender will examine your equity, credit score and debt-to-income ratio. These three elements are all taken into consideration so if you’re weak in one area, the other two can help boost your qualifications.
Step 1: Get Your Home Appraised
To determine whether you qualify and how much money you can borrow, a lender will have your home appraised. The home appraisal will tell the lender how much your home is worth.
Rocket Mortgage will allow you to borrow up to 90% of the equity in your home (with qualifying credit). To figure out the amount you could obtain through a home equity loan, you’d determine your loan-to-value ratio (LTV). To do this, subtract the remaining balance of your primary mortgage from 90% of the appraised value of your home. For example, if your home is appraised at $400,000 and the remaining balance of your mortgage is $100,000, here’s how you would calculate the potential loan amount:
This means you could secure up to $260,000 if you obtained a home equity loan.
Step 2: Calculate Your Debt-To-Income Ratio
When deciding whether to provide you with the loan, your lender will calculate your debt-to-income ratio (DTI), which shows how your monthly debt payments compare to your monthly income. This calculation helps lenders determine whether you can afford to take on more debt.
To qualify for our Home Equity Loan, your DTI cannot be higher than 50%. To see if you make the cut, you can figure out your DTI yourself, using the following equation:
DTI = Total Monthly Debt Payments ∕ Gross Monthly Income
Add up all your monthly debt payments, including your primary mortgage, student loans, car loan, minimum credit card payment, alimony, child support, etc.
Divide the sum by your gross monthly income, which is the amount of money you earn each month before taxes and deductions.
Multiply the result by 100 to find the percentage.
For example, if your total monthly debt is $1,500 (let’s say $950 for your primary mortgage + $300 for your car loan + $250 for your credit card debt), and you earn $5,000 a month before taxes, your DTI would be 30%. In this scenario, your DTI would be low enough to qualify for a Home Equity Loan.
The strength of your credit score also plays a role in determining whether you qualify for a home equity loan. Your credit score is important because it helps lenders understand your credit history. Individuals with higher credit scores often benefit from lower interest rates.
If you want to obtain a home equity loan, a higher credit score will give you more flexibility on terms. For example, higher scores may allow you to access more of your equity. Here's how things work at Rocket Mortgage.
With a 680 credit score, you're limited to accessing up to 80% of the equity you have in your home. If your FICO® Score is a median of 700 or better, you can access up to 85%. Finally, you can borrow up to 90% of the available equity in your home if your score is 740 or higher.
Remember that these LTV amounts combine both your primary mortgage and your new Home Equity Loan. For example, if you have 45% LTV on your primary mortgage, you can only borrow a further 45% of your home value for a total of 90%.
Getting A Home Equity Loan With Bad Credit
Those who have had past credit issues know that it tends to be easier and less costly to obtain a home equity loan than a personal loan. The reason for this is there is less risk involved for lenders because home equity loans are secured by your home. On the other hand, if you’re unable to keep up with your monthly payments, the lender can foreclose on your home to recoup costs.
If you’ve built up a fair amount of equity in your home and have a low debt-to-income ratio, your chances of obtaining a home equity loan will be higher despite a low credit score. If you find yourself in this situation, your home equity loan will likely come with higher interest rates and fees.
If your finances demonstrate to lenders that you may be unable to repay the money borrowed, you’ll find it more challenging to obtain a home equity loan. Since the housing crisis, more restrictions have been placed on lending practices. What are the home equity loan rates?
Home equity loan rates are dependent upon the prime rate, credit score, credit limits, lender and loan-to-value (LTV) ratios.
In addition to your credit score, lenders evaluate your debt-to-income (DTI) ratio when applying for a home equity loan. If you already have a lot of outstanding debt compared to your income level, taking on a new monthly home equity loan payment may be too much based on the lender's criteria.
In many cases, lenders will set a minimum 620 credit score to qualify you for a home equity loan — though the limit can be as high as 660 or 680 in some cases.
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Home equity loans are relatively easy to get as long as you meet some basic lending requirements. Those requirements usually include: 80% or lower loan-to-value (LTV) ratio: Your LTV compares your loan amount to the value of your home. For example, if you have a $160,000 loan on a $200,000 home, your LTV is 80%.
HELOCs and home equity loans are the most common way to tap home equity, but they are hard to get, and nearly half of homeowners fail to qualify. The denial rates for HELOCs are 46%, compared to 12% for a conventional mortgage.
Lenders require an appraisal for home equity loans to protect themselves from the risk of default. If a borrower can't make monthly payments over the long-term, the lender wants to know it can recoup the cost of the loan. An accurate appraisal protects borrowers too.
The maximum amount a lender will offer you is typically 80% to 85% of your combined loan-to-value (CLTV) ratio, a measure of the difference between the value of your house and how much you are borrowing.
Typically, HELOCs will have lower interest rates and greater payment flexibility, but if you need all the money at once, a home equity loan is better. If you are trying to decide, think about the purpose of the financing.
10-year fixed home equity loan: 10-year fixed rate home equity loans currently have an average interest rate of 8.79%. At that rate, the monthly payment on a 10-year $10,000 home equity loan would be $125.54.
If you took out a 10-year, $100,000 home equity loan at a rate of 8.75%, you could expect to pay just over $1,253 per month for the next decade. Most home equity loans come with fixed rates, so your rate and payment would remain steady for the entire term of your loan.
For this example, we'll calculate the monthly cost for a $25,000 loan using an interest rate of 8.75%, which is the current average rate for a 10-year fixed home equity loan. Using the formula above, the monthly payment for this loan would be $313.32 (assuming there are no extra fees to calculate in).
Your personal debt load, income and credit score will also help determine your loan amount and interest rate. But remember: The stakes are higher with a home equity loan because it's secured by your home. If you can't make your payments, the lender could foreclose on your house.
Home equity loans ideally should be used to finance home improvements or consolidate debt at a lower interest rate — but not to cover holiday, vacation or everyday expenses, buy a car, or invest.
As we mentioned in #1 above, failure to pay on your home equity loan can result in your losing your home. If you can't make your payments, the lender could foreclose. You may think you have a secure job and then the unexpected happens and you lose it. With it goes your ability to pay on your loan.
To qualify for a home equity loan or line of credit, you'll typically need at least 20 percent equity in your home. Some lenders allow for 15 percent. You'll also need a solid credit score and acceptable debt-to-income (DTI) ratio.
There are no limits on how you can use the money from a home equity loan. Since all the money is provided upfront, it is often used to pay for big projects like home renovations.
Your credit history, debt-to-income (DTI) ratio, and the amount of home equity you have play a role in determining if you will be approved for a home equity loan. With better credit, you can qualify for better interest rates.
Every loan requires some level of documentation, but some home equity loans will allow you to qualify without traditional income verification, such as pay stubs and tax returns. Instead, the lender relies more heavily on other aspects of your application, such as your credit score or bank statements.
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