Whether we refer to a traditional home equity loan or home equity lines of credit (HELOC), home equity financing options allow homeowners to finance home improvements or repairs, make down payments on second homes, consolidate debt, cover unexpected expenses like medical bills, and pay for other non-housing needs.
Although the number of homeowners tapping into home equity has increased over the years, these loans come with specific requirements that are similar to those of conventional mortgages. This means that not all applicants who intend to take out a home equity loan can qualify for one. Here we present a number of factors lenders consider when determining a borrower’s eligibility for an equity loan.
The Amount of Equity
A home equity loan is money borrowed against your home equity, which represents the difference between the current market value of a home and the amount still owed on the mortgage. In general, borrowers need to have at least 20% equity in their homes in order to qualify for an equity loan. If a piece of property is valued at $250,000, for example, and the homeowner still owes $200,000 on the mortgage, he or she has $50,000 in equity, or 20%.
To determine how much a home is worth, a lender will require a home appraisal to be performed by a licensed appraiser. If the home’s value has decreased, the amount of equity might be lower than expected, even if the homeowner has been making timely mortgage payments for years.
No matter how much equity applicants have in their homes, lenders want to know that they can afford the equity loans they intend to take out. To qualify for an equity loan, therefore, a prospective borrower needs to prove that he or she makes sufficient income to cover the cost of current debt as well as the additional debt he or she will be taking on.
A noteworthy point is that lenders are required to make good faith efforts in order to determine if potential borrowers are able to repay their loans. For this, lenders consider the income, assets, credit scores, credit histories, employment, monthly expenses, and any other factors that can affect the credit situation of applicants.
Debt-to-Income (DTI) and Loan-to-Value (LTV) Ratios
The maximum DTI ratio accepted by most lenders is 43%. This means that lenders rarely approve loans for borrowers who are spending more than 43% of their income on debt. To calculate DTI ratios, lenders add up mortgage payments, homeowner’s insurance premium, taxes, HOA fees, direct liens, and any other outstanding debt. The total monthly debt is divided by the gross monthly income.
Additionally, lenders use LTV ratios to determine the amount a potential borrower can qualify for. The LTV ratio is calculated by adding the outstanding mortgage balance to the amount an applicant wants to borrow. That figure is then divided by the current market value of the home. Although an LTV ratio below 80% ensures the eligibility for an equity loan, some lenders are willing to approve loans with higher LTV ratios, provided that borrowers meet the other requirements.
Before applying for equity loans, homeowners should calculate their DTI and LTV ratios. If these two ratios exceed the limits required, applicants can improve their odds of getting approved for a home equity loan by paying off debt or finding additional sources of income.
North Florida Mortgages uses both experienced underwriters and advanced technology to analyze applications. Besides being intuitive and personalized, our unique approach allows a high number of homeowners to tap into their home equity without having to navigate a complicated and rigid mortgage application process.