How to qualify for a home equity loan
Have you ever worried or wondered how you might afford bigger home improvement purchases? Maybe you’ve stood on your back porch and thought, “we need a pool”, but didn’t know how to pay for it. Or maybe you’ve stood in your garage and worried about replacing the old door. Perhaps, you’ve stood in your kitchen and visualized the big remodel. The answer in each of those situations could be the very place you were standing - your house. How do you use your house to cover large expenses? One common answer is through a home equity loan.
What is a Home Equity Loan?
A home equity loan is a loan paid out in a lump sum, using your home as collateral. With a home equity loan, you’re taking out a second loan for only the amount that you own in equity - leaving you with two mortgage payments.
This differs from a cash-out refinance where the lender will refinance the remainder of your mortgage for the full amount of your home’s value and allow you to use the difference on something like home improvements.A cash-out refinance leaves you with one, refinanced mortgage.
A full refinance could include more upfront costs, which is why you might prefer a home equity loan. Additionally, interest rates could be higher than what you have on your current mortgage. If so, refinancing your mortgage may be a bad idea. Instead, you could choose a home equity loan and refinance later when rates come down to combine the two payments into one mortgage.
How can you use the funds?
Funds from a home equity loan can be used to pay for many different things. Common things people use a home equity loan for include:
- Home Improvements
- College tuition and expenses
- Business ventures
- Health expenses
- Buying a car
- Debt consolidation
- Various products and services
If you want to purchase more real estate, you may be able to use the money from a home equity loan, but it depends on the situation. If you are able to pull enough out to buy a second home in cash, then you likely won’t have any problems. However, if you are using the money as a down payment, your mortgage lender may have restrictions on where it can come from. Be sure to discuss your options with your lender first.
How to calculate your loan amount
Home Value - $250,000
Percentage from lender - 80%
Amount you owe on home - $150,000
$250,000 x 80% (or .8) = $200,000
$200,000 - $150,000 = $50,000
In this instance, you’d be able to get a loan of up to $50,000. We have many Home Equity calculators for you on our calculators page, to get started use this home equity calculator to easily calculate the equity in your home.
The amount you can qualify for depends on how much equity you own. Equity is the part of your home’s value that you have already paid off. Lenders are usually willing to lend up to 80% - 85% of your home's value in a home equity loan, which means you need to own at least 15% - 20% equity in your home.
To calculate your possible loan amount, multiply your home’s value by the percentage the lender is willing to lend. Then subtract the amount you still owe on the home.
How to qualify for Home Equity Loans
When applying for personal loans or mortgages, there are some things - like your credit score and income level - that lenders will look at. When applying for a home equity loan, lenders will look at additional information beyond these primary factors. Here are some ways to improve your chances of qualifying.
Make sure you own enough equity in your home - The main consideration when looking at a home equity loan is how much equity you own versus how much you want to borrow. You’ll need to have at least 15%-20% equity to be considered. However, having more equity and borrowing less will help you get approval.
For example, if you still owe 70% of your home’s value and want to borrow 10% more, this may or may not be approved since you would be getting close to the maximum of 80%-85%. However, if you only owe 20% of the value of your home and want to borrow 10%, this would be far less risky to a lender and may be easier to get approved.
Improve your Credit Score - As with any loan, you will need to have a certain credit score in order to qualify. According to Rocket Mortgage¹, you should have a score of 620 or higher for a home equity loan. If your score is above 700, it is even more likely you’ll get approved.
Before applying, take steps to improve your credit score by doing things like paying down debt or limiting the number of new credit accounts.
Read More: How to check and improve your credit score.
Stay up to date with payments - Lenders always consider whether or not you’ve made payments on time when evaluating you for a loan. Delinquent accounts and late payments indicate that you may be extending yourself too far with your credit. Make sure you are on time with your payments before you apply.
If you are on time with your payments currently, but had trouble in the past, then approval could depend on how recent those missed payments are. If it’s been two years since your last missed payment, then a lender may not be concerned. A late payment within the past year could pose a problem.
Lower your Debt-To-Income (DTI) ratio - When considering your ability to make monthly payments, lenders will make sure you don’t already have too much debt compared to your monthly income. They calculate your debt to income ratio (DTI) to see if you are already carrying too much debt. DTI is a percentage that shows how much of your monthly income is consumed by debt payments. DTI is calculated by dividing your debt payments by your monthly income. For instance, if you make $5,000 a month and your debt payments add up to $1,500 a month, then your DTI is .3 or 30%. The equation would look like this:
$1,500 / $5,000 = .3 or 30%
Lenders prefer your debt to income ratio to stay below 43%, with some shooting for 36% according to NextAdvisor². Keep this in mind as you may need to pay off some debts or increase your monthly income in order to get your DTI ratio where it needs to be.
When you should (or shouldn’t) get a Home Equity Loan
If you have a big purchase to make, taking out a home equity loan could be the right choice if:
- You need more than $10,000
- You have substantial equity in your home from years of making mortgage payments
- You know how much you need
- You need all of the funds up front
- You can start paying on the loan right away
- Interest rates are higher than what you have on your current mortgage
However, a home equity loan may not be the best option if:
- You need less than $10,000
- You are early on in your mortgage and don’t have enough equity
- You’re not sure how much you will need
- You don’t need all the funds right away
- You need time before you can start making payments
- Interest rates are lower than what you have on your current mortgage
In these instances, you may be better off getting a personal loan, credit card, or a Home Equity Line of Credit.
Home Equity Loan vs. Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (HELOC) acts like a credit card that is backed by the equity in your home. Instead of receiving money in a lump sum and paying it back in fixed payments like a home equity loan, you are given access to funds that you can withdraw during the draw period - normally around 10 years, according to Bankrate³. During this time you may be required to make payments on the interest. Once the draw period is over, you enter into the repayment period when you repay the loan for however much you withdrew.
While home equity loans have fixed interest rates, HELOC’s have variable interest rates, making your payments harder to predict. You can normally get a discounted rate, but after an initial period, it may increase. (Nerdwallet⁴)
The benefit of getting a home equity loan is that you receive the money all at once and your payments will remain the same with a fixed interest rate and a fixed payment that includes principal and interest.
The benefit of going with a Home Equity Line of Credit is that you can access the money only when you need it and there is a delay between when you borrow it and when you have to start paying it back.
If you’re ready to put this information into action, we’re ready to help. At Southern Bank you can get a fixed competitive rate on your loan with no prepayment penalties. You’ll get help from a real person who can help you access up to 80% of the equity in your home.
To get started you can visit a local Southern Bank branch or contact one of our lenders.
Disclosures & References:
1 Andrew Dehan, Home Equity Loans: A Complete Guide, rocketmortgage.com, Feb. 16, 2022, https://www.rocketmortgage.com/learn/home-equity-loan
2 Stephen J. Bronner, Home Equity Lending Requirements: Here’s What You’ll Need to Get a HELOC or Home Equity Loan in 2022, NextAdvisor.com, Jan. 5, 2022, https://time.com/nextadvisor/loans/home-equity/requirements-for-home-equity-loan-heloc/
3 Jerry Brown, Requirements for a Home Equity Loan or HELOC in 2022, Bankrate.com, Oct. 5, 2021, https://www.bankrate.com/home-equity/requirements-to-borrow-from-home-equity/
4 Kate Wood, How a Home Equity Loan Works, Nerdwallet.com, Jul. 9, 2020, https://www.nerdwallet.com/article/mortgages/home-equity-loan