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Home Equity Loan Requirements in 2020

Homeownership has several benefits, including the opportunity to borrow against the equity you build. To help you decide if a home equity loan is right for you, let’s explore the key home equity loan requirements, as well as the advantages and drawbacks, of these loan products in depth.

What is a home equity loan?

A home equity loan allows you to borrow against the equity you have in your home. Home equity is the difference between your mortgage balance and your home’s market value.

Your home is used as collateral for a home equity loan — as is the case with the mortgage you took out when you bought your home. This type of loan is also called a second mortgage, because it takes second priority after your first mortgage when debts need to be repaid in a foreclosure.

Home equity loan terms often range from five to 20 years, and sometimes up to 30 years. The loan is paid to you in a lump sum, and you’re generally given both a fixed interest rate and fixed monthly payments as part of your agreement to repay the money.

Common uses for a home equity loan include:

  • Making home improvements.
  • Consolidating high-interest debt.
  • Paying for higher education expenses.
  • Buying an investment property.
  • Starting a business.

A home equity loan shouldn’t be confused with a home equity line of credit, or HELOC. Similar to a credit card, you only use the money you need and make monthly payments based on your outstanding balance and interest owed on a HELOC. You can take out as much (or as little) money you need from your credit line until you reach the limit. Unlike home equity loans, HELOCs typically come with variable interest rates.

Home equity loan requirements in 2020

Wondering how to qualify for a home equity loan in 2020? You’ll need to meet the following requirements.

Home equity

To get approval for a home equity loan, you’ll need equity in your home. If your home is worth $300,000 and you owe $100,000 on your mortgage, you have $200,000 in equity. Home equity lenders typically cap loan amounts to 85% of your available equity, according to the Federal Trade Commission.

Your loan-to-value (LTV) ratio should be 85% or lower, meaning you still have at least 15% equity in your home after taking out a home equity loan. Using the example above, your current LTV ratio is approximately 33% ($100,000/$300,000). If you take out a $100,000 home equity loan, your combined LTV ratio would be about 67%.

Your lender may order an appraisal to verify your home’s value and your available equity.

Credit score

You must have at least a 620 credit score to get a home equity loan, but your lender could impose an even higher minimum, such as 660 or 680. To get the best rates, shoot for a credit score of 740 or higher, but know that it’s possible to qualify for a home equity loan with bad credit.

Debt-to-income ratio

You’ll need to show you earn enough money to manage your current monthly obligations, plus a home equity loan. Your debt-to-income (DTI) ratio tells your lender whether you can handle the added debt or will be stretched too thin.

Your DTI ratio shouldn’t exceed 43% for a home equity loan, but you may qualify with a ratio as high as 50%, depending on your lender.

Credit and payment history

Lenders must determine whether you’re able to repay any mortgage loans you take out, including a home equity loan. They’ll review your overall credit history, including:

  • The types of credit you have.
  • How much you owe on those accounts.
  • The length of years the accounts have been open.

Your payment history is also scrutinized — whether on-time or late — as well as any accounts you have in collections.

Pros and cons of a home equity loan

Keep the pros and cons of a home equity loan in mind as you decide whether it’s the right choice for you.

Pros

  • Fixed monthly payments. Because it’s an installment loan with a fixed rate over a set term, your home equity loan will have the same payment amount each month.
  • Low interest rates. In many cases, home equity loans have lower interest rates than credit cards or personal loans. At the time of publication, the average rate for a $50,000 home equity loan is less than 5%, according to LendingTree data.
  • Tax benefits. Home equity loan interest is tax-deductible, through the mortgage interest deduction, if proceeds are used to buy, build or substantially improve your home. You’re not allowed to deduct interest if the loan was used for personal expenses, such as debt consolidation or paying college expenses.

Cons

  • Reduction of home equity. It takes time to gain equity in your home. When you borrow against it, you’ll need additional time to rebuild the equity you once had.
  • Risk of going underwater. If home values in your area drop, you could become underwater on your first mortgage and home equity loan. This can create issues when you’re ready to refinance or sell.
  • Your home is collateral. The biggest drawback to using a home equity loan is that it puts your house on the line. If you fail to repay your loan, the lender has the right to foreclose on your home to recoup your debt.

Home equity loan alternatives

If you’re uncertain about a home equity loan, consider the following options.

  • HELOC. HELOC requirements are somewhat similar to those of a home equity loan, but remember that it’s a revolving credit line and you only make payments based on the amount used. If you need flexibility and you’re able to pay off your loan in a shorter time frame, a HELOC may be a better choice.
  • Cash-out refinance. A cash-out refinance allows you to replace your old mortgage with a new one and take the difference between the two mortgages in cash. Compare the differences between cash-out refinancing, home equity loans and HELOCs.
  • Personal loan. Depending on your credit score and income, you can take out an unsecured personal loan instead of borrowing from your home’s equity. There’s no collateral requirement to secure the loan, but it may come with a higher interest rate and a shorter repayment term.
  • Credit card. A credit card can be a quicker way to access the money you need. Carrying a balance on your credit card is pricey, though, as credit cards usually have higher interest rates than the other alternatives discussed above.
 

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