What Are The Requirements For A Home Equity Loan Or HELOC?

What Are The Requirements For A Home Equity Loan Or HELOC?
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Equity in a home typically can’t be accessed until the house is sold, but a home equity loan or HELOC can turn your home equity into cash. This can be beneficial if you need immediate access for funds to pay down debt, fund a home improvement, or even pay for a wedding.  While it is your equity you are taking out, but there are still borrowing requirements.

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A home equity loan or home equity line of credit (HELOC) are two of the most common ways homeowners use to access built-up equity. Home equity loans offer lump-sum payments at a fixed interest rate that is repaid over a specified period. A HELOC is a revolving line of credit that functions like a credit card backed by your home as collateral. You can draw on the balance several times during the loan’s draw period. These types of loans start with an adjustable-interest rate period, followed by a fixed-rate period. Cash-out refinancing is also an option, where you refinance an existing mortgage into a loan for more than you owe. You keep the difference in cash.

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Borrowing for each of these types of loans varies according to your lender. Some typical things to keep in mind when deciding whether this type of home loan is right for you are included below. Most lenders will require you to meet these baseline requirements to be eligible.

  • At least 15%-20% equity in a home needed, the lender will appraise home
  • Debt-to-income ratio of at least 50%
  • Credit score higher than 620
  • Strong history of paying bills on time

Debt-To-Income Ratio

Your debt-to-income ratio is important for lenders to judge whether or not you can afford a home equity loan. Lenders will want to know all of your current monthly debt payments and financial obligations to help determine this number. These financial obligations divided by your monthly income is your debt-to-income ratio.

If your DTI is too high, you may not be eligible for a home equity loan. Federal regulations set the minimum DTI ratio for a fixed-rate home equity loan at 43%. Most lenders will want to see a borrower with a lower DTI for more favorable terms.

HELOCs typically follow these standards too, though lenders have more discretion in the DTI ratio. Some lenders will offer HELOCs to borrowers with 50% DTI ratio. Qualifying for a home equity loan or HELOC requires careful planning for how much debt you plan to take on.

Credit Score

Your credit score also plays a role in determining whether you are qualified for a home equity loan. The minimum FICO score for home equity borrowing is 680 at most lenders. Most lenders use formulas that take credit score into account when determining eligibility. However, a credit score is not the defining factor.

Borrowing Limits

Even if you are approved for a home equity loan, most lenders will only approve 80% of the property's value minus any mortgaged debt. A lower debt-to-income ratio will increase the percentage your lender is willing to give you for home equity. An appraisal is needed even to start the process, so be prepared to pay for that upfront.

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Ankur Shah is the founder of the Value Investing India Report, a leading independent, value oriented journal of the Indian financial markets. Ankur has more than eight years of equity research experience covering emerging markets, with a focus on India and South East Asia. He has worked as both a buy-side investment analyst for a global long/short equity hedge fund and a sell-side analyst for an emerging markets investment bank. Ankur is a graduate of Harvard Business School. You can learn more about his latest views on global markets at the Value Investing India Report. -- He can be emailed at AnkurShah47@gmail.com
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