Home Equity Loan Requirements: What You’ll Need to Qualify
Home equity is one of the key benefits of owning a home. You can borrow against your equity to pay for home renovations, college education or any other expenses that come up.
Though criteria may vary slightly by lender, there are basic home equity loan requirements that you’ll need to meet to qualify regardless. If you’re deciding whether a home equity loan is right for you, we’ll walk you through the requirements and what you need to know.
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What is a home equity loan?
Home equity is the difference between what you owe on your mortgage and what your home is worth. A home equity loan, sometimes called a second mortgage, is a loan you take out using your home equity as collateral. 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 (HELOC). A HELOC is more like a credit card: you get a certain amount that you can spend as needed 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; 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.
Current home equity loan rates
The interest you’ll pay on a home equity loan is typically higher than what you’ll find on a 30-year fixed mortgage. For example, as of Nov. 10, 2022, the average ARR for a 30-year fixed rate mortgage is 6.75%, but the average APR for home equity loans is 8.43%.
You’ve probably heard that interest rates are rising quickly. To put it in perspective, between October 2021 and October 2022, 30-year fixed mortgage rates increased by over 125%, reaching and eventually exceeding 7%. We haven’t seen rates that high in decades. While home equity rates aren’t tied directly to the prime rate like HELOC rates are, they do tend to follow the broader rates environment. Between October 2021 and October 2022, for example, the average home equity loan APR rose by 43%.
Home equity loan requirements
Home equity loan requirements tend to be higher than the requirements for a typical first mortgage. The exact rules will vary by lender, but there are some general guidelines that most lenders follow:
Debt-to-income ratio: 43% or less
Your debt-to-income (DTI) ratio measures the monthly obligations you currently have compared to your monthly income. To calculate your DTI 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 DTI 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. 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%
You need to have a minimum amount of equity to qualify for a home equity loan. Many lenders will have a loan-to-value limit for a home equity loan, which means that the more equity you have, the larger the amount you’ll be able to borrow. The loan-to-value (LTV) 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 LTV ratio is 80% and equity is 20%.
Oftentimes, you are required to have at least 15% equity in your home to qualify for a loan (an 85% LTV ratio), though many lenders will go beyond this threshold. FDIC guidelines recommend that lenders require mortgage insurance or other special protections once the LTV goes beyond 90%. Mortgages like this are sometimes called high-LTV loans.
Pros and cons of home equity loans
Lower borrowing costs compared to credit cards or personal loans
Fixed monthly payments
May be tax-deductible
Flexibility in how you use the money
Less directly affected by rising interest rates than HELOCs
Substantial closing costs
Raises debt, reducing your available equity
Comes with the risk of foreclosure if you default
Difficult to qualify for
Less flexibility in how, when and how frequently you can access funds compared to a HELOC
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 original 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
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.
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 loans are a type of installment loan, usually with a fixed interest rate. As with 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 and can be sued if you default on the loan.
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 will likely be lower than you’d be able to borrow with a home equity loan, and interest rates after the introductory period can be steep.
If you have a significant sum invested in CDs and hit an unexpected financial emergency, you may wish you could get at those funds without having to pay early withdrawal fees. CD-secured loans are one way to access a lump sum without actually pulling your money out of the CD. You can usually get a loan for the full amount you have invested without paying a high interest rate.
Balance transfer credit card
If you have strong credit but are carrying high-interest debt, a balance transfer credit card can consolidate your debt and give you a period of up to 21 months to pay down the principal balance without worrying about interest. You’ll usually have to pay a balance transfer fee, but if you can pay down your debt fast enough to match your interest-free intro period, a balance transfer credit card could save you much of the pain of your high-interest debt.
If you’re struggling to stay on top of your debts and expenses, a credit counselor can help. Beyond simply offering advice, credit counselors can assist you as you create and execute a debt management plan. During this process, the counselor may help you get discounts from your creditors on interest rates and fees, or lower your monthly payments.
Frequently asked questions
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.
Every lender operates at its own speed, but since the process to underwrite a home equity loan is similar to a standard mortgage, you can expect it to take about the same amount of time. The average time to close on a home loan is 51 days.
There’s no rule or law to prevent you from getting multiple home equity loans, however, you’ll be limited by your equity. If you took out the maximum amount on your first home equity loan, you may not have enough equity left to support another loan.
Home equity loans are usually offered with loan terms that range from five to 30 years, but the loan term that’s right for you will be largely determined by the monthly payments. If you’re taking out a large amount, you may be able to afford a 30-year loan but be in over your head with a five- or 10-year loan.
How much you can borrow depends on how much home equity you have, your credit score and other factors. A home equity loan calculator can help you estimate how much you might be able to borrow.