You have a VA mortgage, and now you want a home equity loan. Is that possible? Can those two coexist?
In principle, there's no reason the two can't run together. Your mortgage may be guaranteed by the VA, but it's provided by a private lender, and typically there's nothing in the rules to stop you from having a home equity loan or home equity line of credit (HELOC) alongside it. However, the VA doesn't guarantee home equity products, so you'll be sourcing yours from the open market, without any of the privileges your service earned you when you originated your mortgage.
Qualifying for a Home Equity Loan
That means your private lender is going to want you to have all three of the following things:
- A good credit score. FICO, the company behind the scoring systems used in many lending decisions, suggests you'll probably be lucky to qualify at all if your score is below 620. But one that's just over that could still make your loan expensive. FICO reckons, on average, those with scores in the 620-639 range pay an interest rate of 10.57 percent on this sort of borrowing, while those in the 740-850 band pay just 4.57 percent. On a 15-year, $50,000 home equity loan, those with scores in the lower range pay $171 more every month than those in the higher range. That's $2,052 a year, or more than $30,000 over the lifetime of the loan. Naturally, there are a number of bands between those extremes, but the principle remains the same: The higher your score, the lower the rate you're likely to pay. LendingTree has a free credit score service that lets you monitor – and helps you manage – yours.
- An ability to make payments. That sounds obvious, but lenders are going to want you to prove you can afford to maintain the loan. That means disclosing a great deal about your personal finances, including your income, existing debt and outgoings. Expect to be asked for evidence in the form of supporting documentation. Of course, your existing borrowing and its effect on your outgoings should be less of an issue if you're borrowing to consolidate debt.
- Plenty of equity. This might be the biggest issue for some with VA mortgages. Most lenders insist the total value of the borrowing secured on your home (that's usually the current balance owed on your VA mortgage plus your new home equity loan, but other unsecured debts don't count) is no more than 75 to 80 percent of the current market value of your home. If someone uses the jargon "loan-to-value ratio" (LTV), that's what they're talking about.
Refinancing Your VA Loan When You Have a Home Equity Loan
One point to consider before applying for a home equity product is the impact it might have if you later decide to refinance your VA mortgage. This arises only occasionally, but you may want to check with your prospective lender now so that it won't be an issue for you down the road. It's a bit technical, so be patient: Borrowing secured on your home is called, in legal jargon, a "lien" (a right to repossess your home if you seriously breach your loan agreement), and your first lien is your VA mortgage, meaning it gets priority if foreclosure becomes necessary. However, if you refinance, your home equity loan or HELOC automatically moves up to first place because it becomes the older lien, and that lender gets priority. No mortgage lender is going to live with being in that second slot, and the one refinancing yours will pretty much invariably insist it must be first.
This can be easily resolved by the home equity lender providing a "subordination agreement," which is a document saying it's willing to remain holder of the second lien. Most providers of home equity products provide these on request, but a few don't. So you might want to get a letter from your new lender saying it won't be a problem.
This prompts the question, should you just include your home equity borrowing in a later cash-out refinancing, paying off the first using the proceeds of the second? That might be a good move, but it often isn't.
Home equity products provide some of the most affordable borrowing out there. They can be a smart and useful choice, but they have to be taken seriously and are best viewed within your overall financial strategy. It's a good idea to read up on them before you commit so you can fully recognize that strategic role.