Why Would a Home Equity Loan Be Denied?

Applying for a home equity loan can be an excellent way to tap into your home’s equity and get funds for home improvements, debt consolidation, or other major expenses. However, being approved for a home equity loan is not guaranteed. Lenders use specific criteria to determine if an applicant qualifies, and sometimes applicants are denied If you’ve been rejected for a home equity loan, it’s understandable to feel disappointed and wonder what went wrong This article will explore the top reasons why a home equity loan application may be denied and provide tips on what you can do if this happens.

Common Reasons for Home Equity Loan Denial

There are a few key factors lenders evaluate when reviewing a home equity loan application. Failing to meet the lender’s criteria in one or more areas often leads to a denial. Here are some of the most common reasons borrowers are rejected:

Low Credit Score

Your credit score gives lenders insight into your past credit behavior and repayment history. In general, lenders prefer borrowers to have a FICO credit score of at least 620 to 660 to qualify for a home equity loan. Applicants with scores below this range are often denied or only approved for less favorable loan terms. A low credit score signals higher risk of default to the lender.

High Debt-to-Income Ratio

Lenders calculate your debt-to-income (DTI) ratio by dividing your total monthly debt payments by your gross monthly income. Most lenders look for a DTI of 43% or less on home equity loans. If your DTI is too high, the lender may determine the additional monthly loan payment is unaffordable for your income level and deny the application.

Insufficient Home Equity

To qualify for a home equity loan, you need sufficient equity built up in your home. Many lenders require a minimum of 15-20% equity. They also evaluate your combined loan-to-value ratio, which factors in the new loan amount plus any existing mortgage debt on the home. Too little equity compared to the value of your home could result in denial.

Limited or Unstable Income

Lenders want to see consistent income over time. Insufficient income relative to the loan amount requested or income that fluctuates wildly from month to month may cause a lender to deny the application due to concerns about repayment ability. Providing proof of income is a standard part of the home equity loan application process.

Poor Payment History

Your payment history on other debts, such as credit cards, auto loans, student loans, and mortgages, provides insight into how you may handle a home equity loan Too many late payments or instances of non-payment in your credit history represent increased risk to the lender and could lead to denial of the home equity loan

Job Change or Employment Gap

Starting a new job shortly before applying for a home equity loan or having a gap in employment could negatively impact your chances of approval. Most lenders want to see at least 6-12 months of stable employment in the same industry or company. Job changes or employment gaps may cause the lender to view you as a higher risk.

Bankruptcy or Foreclosure History

Major derogatory credit events like bankruptcy, foreclosure, short sale, or deed in lieu can severely hurt your approval odds for a home equity loan. These types of events can stay on your credit report for up to 7-10 years and make it challenging to qualify until they drop off your credit history.

Home Value Decline

If your home has decreased significantly in value, you now have less equity available to borrow against. The lender may determine you no longer meet the minimum equity requirements based on the current lower home value and appraisal. This could lead to your home equity loan application being denied.

What to Do If You Are Denied

If your home equity loan application gets rejected, don’t panic. Here are some tips on steps to take next:

• Request an adverse action notice. Federal law requires lenders to provide an adverse action notice if they deny your application. This notice outlines the specific reason(s) for the denial. Review it closely to understand where your application fell short.

• Get a copy of your credit report. Look over your credit report from all three bureaus for any inaccuracies that may be impacting your score. Dispute any errors with the bureaus to potentially improve your credit profile.

• Work on improving your credit. Building your credit score and history over time can significantly improve your chances for home equity loan approval down the road. Make on-time payments, pay down balances, and limit new credit applications.

• Pay down existing debts. Reducing your monthly debt obligations and overall DTI will strengthen your application if you reapply for a home equity loan in the future. Pay down credit card and auto loan balances to lower your DTI.

• Increase your down payment. Coming back with a larger down payment next time decreases your LTV ratios and demonstrates you can now meet the equity requirements. Save aggressively for a bigger down payment.

• Provide more documentation. If you were lacking in providing sufficient income verification or other documents, make sure to gather everything required for your next application. Correct any documentation issues.

• Consider alternatives. A secured loan with collateral, credit cards, personal loans, or loans from family could potentially provide financing if a home equity loan remains out of reach for now.

• Reapply in the future. Once you have had time to improve your financial situation per the lender’s feedback, apply again with another lender. You may have better luck on a second application.

Tips to Get Approved

While not guaranteeing 100% approval, keeping the following tips in mind can maximize your chances of successfully qualifying for a home equity loan:

• Have a credit score above 660. Scores of 660 or higher improve your odds of approval and the loan terms you are offered.

• Maintain a DTI below 40%. Keep your debt-to-income ratio in check. Total monthly debt payments of under 40% of gross monthly income are ideal.

• Document consistent income. Provide the lender ample proof of your regular income over the past 2+ years from employment, retirement, or other verifiable sources.

• Limit applications for new credit. Too many credit inquiries from applying for multiple new credit accounts can hurt your home equity loan application.

• Avoid changing jobs. Try not to change employers during the loan application process. Job changes can raise concerns about income stability.

• Make timely payments. Pay all your bills on time leading up to the application to demonstrate you are a responsible borrower.

• Have sufficient home equity. Make a sizable down payment and pay down your mortgage consistently to build up enough equity in your home to qualify.

• Choose lenders carefully. Work with lenders like credit unions that are known for offering home equity loans to borrowers with less-than-perfect credit.

• Bring a co-signer. Adding a co-signer with better credit or income than you can improve the chances your home equity loan gets approved.

Alternatives If Denied

If you are ultimately denied a home equity loan after several attempts, here are a few potential alternative financing options to consider instead:

• 401(k) or pension loan – These types of loans allow you to borrow against your retirement savings.

• Cash-out mortgage refinance – This converts your existing home loan into a new, larger mortgage to tap equity.

• Federal equity conversion mortgage – Also known as a reverse mortgage, this option is for older homeowners.

• Personal loan – An unsecured personal loan from a bank, credit union, or online lender is one possibility.

• Credit cards – Balance transfer or low intro APR offers may provide short-term financing.

• Family loan – A loan from trusted family members or friends avoids the strict approval process.

• Government assistance programs – Non-profit organizations offer specialized loans and grants.

• Peer-to-peer lending – Borrow from individual investors via an online peer lending platform.

Summary

Being denied a home equity loan can feel discouraging, but does not need to be the end of the road. Now that you understand the major reasons for denial and have tips for improving your chances or finding alternative financing options, you can determine the best path forward. Address any credit, income, or equity issues identified by the lender. With time and a strategy tailored to your situation, home equity loan approval could be attainable for you. Be persistent and explore all options available if getting approved remains a priority.