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Home Equity Loan Requirements in 2022
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When you make your monthly mortgage payments, you’re building equity in your home. Equity is the difference between what you owe on your mortgage and what your home is worth — and one of the key benefits of owning a home is the ability to borrow against this equity to pay for renovations, college education or any other expenses that come up. Lenders have different standards for who qualifies, but there are some standard home equity loan requirements we’ll go over in this article.
What is a home equity loan?
A home equity loan, sometimes called a second mortgage, is a loan you take out backed by the equity in your property. You’ll receive the loan money as a lump sum, and typically pay a fixed interest rate — meaning your monthly payment won’t change.
That’s different from a home equity line of credit, or HELOC. With a HELOC, you get a certain amount that you can spend in multiple draws over time and usually pay the money back at a variable interest rate.
How does a home equity loan work?
The amount you’re able to borrow with a home equity loan is generally set by the amount of equity in your home. You can usually borrow up to 85% of the equity in your home, and the more equity you have, the more you’re able to borrow. You’ll receive the money in a single, lump sum and immediately begin paying the money back with a monthly payment at a fixed interest rate. If you fail to make your payments on your home equity loan, you risk losing the home to foreclosure.
Home equity loan requirements
Home equity loan requirements will vary by lender, but there are some general guidelines that most lenders follow. Before applying for a home equity loan, take a look at your finances to see if you’re likely to qualify.
Debt to income ratio: 43% or less
Your debt-to-income ratio measures the monthly obligations you currently have compared to your monthly income. To calculate your debt-to-income ratio, add up the monthly payments on the loans you have, then divide them into your gross monthly pay. For example, if you have a student loan payment of $400, a car payment of $300, and a mortgage of $1,800 and make a salary of $75,000 per year (or $6,250 per month), your debt-to-income ratio stands at 40%.
To qualify for a home equity loan, your debt-to-income ratio will typically need to be below 43% once your potential new loan payment is factored in. You can lower your debt-to-income in one of two ways: Paying off debt to lower your monthly obligations, or making more money in income.
Credit score: At least 620
In many cases, lenders will set a minimum credit score of 620 to qualify for a home equity loan — though the limit can be as high as 660 or 680 in some cases. However, there may still be options for home equity loans with bad credit.
THINGS YOU SHOULD KNOW
You can find out your credit score by requesting your credit reports from the three major credit bureaus. Under federal law, you’re allowed to receive free copies of your report, which can be requested through the site AnnualCreditReport.com (since the coronavirus pandemic, these reports have been accessible weekly). The biggest factor in your credit score is your payment history — so if you need to boost your score to qualify for a home equity loan, focus on making your payments on time, every time.
Home equity: At least 15%
The amount you’re able to borrow on a home equity loan is limited by the amount of equity you have — but you also must have a minimum amount of equity to qualify. Many lenders will have a loan-to-value limit for a home equity loan. The loan-to-value ratio is the total amount of debt on the home compared to its worth, a measure of equity. For example, if you owe $200,000 on your mortgage but the home is worth $250,000, your loan-to-value is 80% and equity is 20%.
You often must have at least 15% equity in the home to qualify for a loan (an 85% loan-to-value), though many lenders will go beyond this threshold. FDIC guidelines recommend that lenders require mortgage insurance or other special protections once the loan-to-value goes beyond 90%.
Pros and cons of home equity loans
Like any financial product, home equity loans have their pluses and minuses. Consider them carefully before moving forward with a loan application.
| Pros | Cons |
|---|---|
| Lower borrowing costs than other loans Fixed monthly payments May be tax-deductible Flexibility in how you use the money | Substantial closing costs Raises debt, reduces available equity Risk of foreclosure Difficult to qualify for |
Should I get a home equity loan?
You should consider getting a home equity loan if:
→ You want to make home improvements. Home equity loans are commonly used to pay for costly home improvements like renovations and additions. If you use the loan to fix up your home, the interest you pay is usually tax-deductible.
→ You want to pay off higher-interest debt. Home equity loans are also frequently used to consolidate high-interest debt, like credit card debt. Since home equity loans are secured by your home, they usually have lower interest rates than you’ll find on unsecured loans, such as credit cards or personal loans. You may be able to pay off these loans with your new home equity loan, leaving you with a lower interest rate and lower monthly payment.
→ You can afford your mortgage and other monthly expenses. Don’t take out a second mortgage if it’ll break your budget. A home equity loan adds another mandatory monthly payment to your finances, in addition to the mortgage payment and any other loan payments you’ll still have to pay.
Taking out a home equity loan in the wrong situation can have serious implications. Since these loans are secured by your property, failing to make your monthly payments can put you at risk of foreclosure.
Alternatives to home equity loans
Cash-out refinance
A cash-out refinance involves taking out a new mortgage that pays off and replaces your current mortgage, but with a higher amount than you currently owe: The difference will come to you as cash. Interest rates tend to be lower than with a home equity loan, since the loan is a primary mortgage and not a second one. You’ll also pay typical mortgage closing costs.
Home equity line of credit
A home equity line of credit is another loan product based on your home’s equity, but allows you to make multiple draws over time, up to a set limit. Note, though, that HELOCs typically have variable interest rates, meaning your monthly payment is likely to change over the years you are paying it back.
Reverse mortgage
With a typical mortgage, you make payments each month to pay back the loan. In a reverse mortgage, a lender pays you in a lump sum or on a monthly basis (you can also receive payment through a line of credit) based on the equity in your home, and the balance isn’t due until you pass away or leave the home. Reverse mortgages are only open to seniors age 62 or older and are often used as a way to meet expenses in retirement. However, paying off a reverse mortgage often involves selling the home.
Personal loan
Personal loans are a type of installment loan, usually with a fixed interest rate. Like a home equity loan, you receive the proceeds of a personal loan as a lump sum. Personal loans are generally unsecured, meaning there’s no risk of foreclosure — but you will likely pay a higher interest rate.
0% APR credit card
If you’re looking for a relatively short-term loan, a 0% APR credit card may be a good option. These credit cards charge zero interest for an introductory period, but the interest rate jumps back to a normal rate after that time. In addition, credit limits may be lower than you’d be able to borrow with a home equity loan, and interest rates after the introductory period can be steep.
FAQs about home equity loan requirements
What is the minimum credit score needed for a home equity loan?
The minimum credit score required for a home equity loan can vary by lender, but is often set at 620. Some lenders may set higher minimum credit scores, like 660 or 680.
Can I get a home equity loan without a job?
To qualify for a home equity loan, you’ll typically need to document your ability to repay the loan. This includes earning enough income to make your payments. If you don’t have a job, you’ll have to show you have enough income from other sources to make your payments.
How much equity do I need for a home equity loan?
You’ll generally need to have at least 15% equity in your home to qualify for a home equity loan, though some lenders may be willing to lend to you with less equity.
How long does it take to get a home equity loan approved?
While you may be preapproved for a home equity loan more quickly, it generally takes between two to four weeks to close on a home equity loan.