Home Equity Loan Requirements: 6 Qualifications

What are the home equity loan requirements?

To qualify for a home equity loan, lenders generally look for six key criteria. Meeting these qualifications can increase your chances of approval and help secure favorable loan terms.

1. Good credit score of 620 or higher

A good credit score is a crucial factor in qualifying for a home equity loan. Most lenders require a minimum credit score of 620, but having a higher score can improve your chances of approval and help you secure a lower interest rate.

To check your credit score, you can use free services from major credit bureaus or online platforms. If your score is lower than desired, consider steps to improve it, such as paying down existing debt, disputing any errors on your credit report, and ensuring all bills are paid on time.

2. Low debt-to-income (DTI) ratio

Lenders typically look for a debt-to-income (DTI) ratio of 43% or less. This ratio compares your monthly debt payments to your gross monthly income, and a lower ratio indicates better financial stability.

To calculate your DTI, add up all your monthly debt payments and divide by your gross monthly income. For instance, if you pay $2,000 in debt payments each month and earn $5,000, your DTI is 40%.

Maintaining a low DTI ratio not only helps in qualifying for a home equity loan but also demonstrates your ability to manage additional debt.

3. Favorable payment history

A favorable payment history reassures lenders that you are a reliable borrower. Consistently making on-time payments on your debts, including credit cards, loans, and mortgages, is critical in establishing this reliability.

Lenders review your credit report to assess your payment history, looking for patterns of timely payments. If you have a history of late or missed payments, it may be beneficial to show recent improvements or explain any past difficulties.

4. At least 20% equity in your home

Equity is the difference between how much you owe on your mortgage and your home’s value. This determines your loan-to-value ratio or LTV. To find your LTV, divide your current mortgage balance by your home’s appraised value.

If your loan balance is $150,000 and an appraiser values your home at $450,000, you would divide the balance by the appraisal for an LTV ratio of about 33%. This means you have 67% equity in your home.

Most lenders require you to maintain a minimum of 20% equity, although some allow 15%. A loan with a ratio below 10% is called a high-LTV loan and usually comes with higher interest rates and a greater risk of denied funding.

5. Stable and sufficient income

A stable and sufficient income is necessary to ensure you can repay the loan. Lenders require proof of income, including documentation such as pay stubs, tax returns, and employment history.

Your income must be consistent and enough to cover the loan payments in addition to your existing financial obligations. Lenders may also consider your employment stability and history in their assessment.

6. Proof of homeowners insurance

Proof of homeowners insurance is mandatory for securing a home equity loan. This insurance protects the property against potential damages and losses, ensuring the lender’s investment is safeguarded.

Lenders will ask for documentation verifying your current policy is in place and sufficient. Acceptable proof documents might include a letter from your insurer or agent certifying your home coverage, a declaration page, or a full copy of your homeowners insurance policy.

Making certain your property is adequately insured not only meets the lender’s requirements but also provides you with peace of mind knowing your home is protected.

How much of my home’s equity can I borrow?

The amount of equity you can borrow depends on your home’s value and your current mortgage balance. Most lenders allow you to borrow up to 85% of your home’s equity. To determine this, lenders calculate your combined loan-to-value (CLTV) ratio, which includes both your first mortgage and the home equity loan or HELOC.

Let’s use our example home from above valued at $450,000. Your primary mortgage balance is $150,000. This means you have $300,000 in equity, equal to 66.7% of your home’s total value. However, you can’t borrow the full $300,000. In fact, you can’t even $270,000 because as we noted above, most lenders require you to maintain a minimum of 20% equity.

To determine the maximum amount you can borrow, you must account for the loan-to-value ratio we discussed. If your lender requires that your debts not exceed 80% of your home’s worth — that comes to $360,000. You already owe $150,000 with your first mortgage. So, subtracting your current mortgage from your maximum CLTV of $360,000:

$450,000 x 0.8 = $360,000 – $150,000 = $210,000

In this example scenario, you could potentially borrow up to $210,000 of your home’s equity.

Which is better, a home equity loan or HELOC?

Choosing between a home equity loan and a HELOC depends on your financial needs and preferences.

A home equity loan is ideal for large, one-time expenses because it offers a fixed interest rate and consistent monthly payments.

A HELOC, on the other hand, provides flexibility with a revolving line of credit, making it suitable for ongoing expenses or projects. HELOCs typically have variable interest rates, which can fluctuate over time. Consider your financial situation and how you plan to use the funds when deciding which option is better for you.

How much does a home equity loan cost?

The cost of a home equity loan includes interest rates, closing costs, and possible fees. Interest rates are generally fixed and can range from 8% to 10%, depending on your credit score, loan amount, lender policies, and your existing relationship with the lender.

Closing costs can include application or origination fees, title search fees, appraisal fees, and attorney fees (when required), usually totaling 2% to 6% of the loan amount. For example, if you take out a home equity loan of $80,000, you can expect to pay between $1,600 and $4,800 in closing costs.

Some lenders may also charge annual fees or prepayment penalties. It’s wise to compare rates and offers from multiple lenders to find the most cost-effective option.

Home equity loan payment examples

Loan term	Loan amount	Interest rate	Monthly payment
30-year	$75,000	9.15%	$611.58
20-year	$75,000	9.10%	$679.63
15-year	$75,000	9.10%	$765.17
10-year	$75,000	9.10%	$954.13
5-year	$75,000	9.10%	$1,560.52

Source: U.S. Bank home equity loan calculator (As of August 2024 with a 730 credit score)

As you can see in the table above, a shorter-term loan can have a lower interest rate.

What are the drawbacks of a home equity loan or HELOC?

While home equity loans and HELOCs offer access to significant funds, they come with potential drawbacks. Both options use your home as collateral, meaning you risk foreclosure if you fail to repay the loan.

Home equity loans have fixed monthly payments, which can be a strain if your financial situation changes. HELOCs, with their variable interest rates, can lead to unpredictable payment amounts.

Additionally, both types of loans increase your overall debt load, which can impact your financial stability. Consider these risks carefully and ensure you can manage the repayments before borrowing against your home’s equity.

Common alternatives to home equity loans and HELOCs

• Cash-out refinance: This can be a good financing solution for homeowners who need a timely lump sum of money. The process involves refinancing your current mortgage for more than you owe and taking the difference in cash. However, you must be comfortable with refinancing your entire mortgage, which means a new loan contract, term, and a new interest rate.
• Personal loan: This option is often used by borrowers with good credit scores who perhaps lack equity or other collateral. These loans typically have higher interest rates.
• Reverse mortgage: These programs are available to homeowners aged 62 or above who want to access equity-backed funds without new monthly payments. They are a good option for borrowers who have long-term plans to stay in their homes. There are also reverse mortgage programs to purchase a home.
• Retirement plan loan: Some retirement plans, such as a 401(k), allow you to borrow from your own retirement savings. The loan amount may be limited to a percentage of your vested balance or a capped dollar amount.
• Government loans: Some government programs can provide financial assistance for home repairs and improvements, potentially offering better terms than traditional home equity loans.

Less common alternatives to home equity loans and HELOCs

• Home equity sharing agreement: Also known as a home equity agreement (HEA), this is a no-loan option for homeowners with equity who need a lump sum of money without monthly payments. You’ll need some upfront cash and be willing to share a portion of your home’s future equity appreciation with an investment company.
• 0% introductory rate credit card: This personal line of credit can be a short-term option if you can’t qualify for a traditional HELOC because you don’t have enough home equity. This option works best if you can take advantage of a promotional zero-interest offer.
• Rent-back agreement: After selling and receiving proceeds, you retain temporary residency in your home. This can be a strategic option that provides immediate funds to buy or build your next home and also allows you time to locate new living arrangements.

A buy before you sell program may be a solution

If you are a homeowner considering equity-backed financing to purchase a new home to avoid the buy-sell timing conundrum (making two moves), there is a modern way to buy before you sell.

HomeLight’s Buy Before Your Sell program makes it easy to use the equity from your current home to make a strong, less contingent offer on a new home. This innovative program, with its near-instant Equity Unlock Calculator, lets you streamline and simplify the entire buying and selling process.

Here’s how HomeLight Buy Before You Sell works:

If your home qualifies, you can get your equity unlock amount approved in 24 hours or less. No cost or commitment is required. Once approved, you can buy your next home with confidence and then sell your current home with peace of mind.

Should I get a home equity loan or HELOC?

Deciding whether to get a home equity loan or HELOC depends on your financial situation and needs. An equity-backed loan may be a good option for you if:

• You can afford your mortgage and additional expenses: Ensure you have a stable income and can comfortably manage both your existing mortgage and the new loan payments.
• You are paying off higher-interest debt: Using a home equity loan or HELOC to consolidate high-interest debt can save you money on interest payments.
• You’re making home improvements: Investing in your home can increase its value and improve your living space, making a home equity loan or HELOC a smart choice for funding renovations.
• You need funds for large, one-time expenses: A home equity loan is ideal for significant, one-time costs due to its fixed rate and lump sum disbursement.
• You need flexibility for ongoing expenses: A HELOC offers a revolving credit line, making it suitable for covering ongoing or unexpected expenses.

Before deciding, carefully evaluate your financial goals, the costs, and the risks associated with borrowing against your home. Consulting with a financial advisor can also help you make an informed choice.

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If you’re considering a home equity loan to purchase a second property, HomeLight can connect you with a top-rated real estate agent in your market who can provide expert guidance and insights.

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