Home Equity Loan Credit Requirements: What You Need to Know

Getting approved for a home equity loan requires meeting certain credit requirements. While criteria can vary by lender, there are some common standards you’ll need to fulfill.

Understanding these home equity loan credit requirements is key to improving your chances of qualification and securing the best possible rates and terms This comprehensive guide covers everything you need to know

Overview of Home Equity Loans

Before diving into the specifics, let’s quickly go over what home equity loans are and how they work.

A home equity loan is a type of loan that allows homeowners to borrow against the equity they’ve built up in their home. Equity represents the portion of your home that you fully own, calculated by subtracting your mortgage balance from the property’s market value.

With a home equity loan, you receive the money you borrow in a lump-sum payment upfront. The loan amount is fixed, as is the interest rate and monthly payment Terms usually range from 5 to 30 years

Home equity loans differ from home equity lines of credit (HELOCs), which provide revolving credit that you can draw from as needed. HELOCs have adjustable interest rates, while home equity loans have fixed rates.

Key Credit Requirements for Home Equity Loans

When reviewing home equity loan applications, lenders carefully evaluate your creditworthiness to determine if you qualify. Here are some of the top credit requirements you’ll need to meet:

• Credit scores: Most lenders look for a minimum credit score of 620 to qualify for a home equity loan. The higher your score, the better the rates and terms you can get. Borrowers with scores of 740+ are considered excellent candidates.

• Equity: You typically need at least 20% equity in your home to qualify. Some lenders allow 15%. Equity of 20% or more provides a sufficient buffer for the lender.

• Debt-to-income ratio: Lenders want your monthly debt payments, including the new loan payment, to be less than 43% of your gross monthly income. The lower the better.

• Income: You must have adequate and stable income to comfortably support the loan payment. Provide recent pay stubs and tax returns as proof.

• Mortgage payment history: On-time mortgage payments indicate you can handle an additional loan. Most lenders require a clean record with no late payments.

Meeting all the above requirements puts you in a strong position for approval. We’ll now look at each one in more detail.

Credit Score Requirements

Your credit score gives lenders a snapshot of your borrowing and repayment history. In general, the higher your score, the lower credit risk you pose.

Many lenders now approve home equity loans for borrowers with credit scores as low as 620. This is considered “good” credit. Interest rates will be higher with a lower score compared to someone with “excellent” credit above 740.

Here are average home equity loan rates currently available for different credit score tiers:

• 740+ credit score: 6% interest rate
• 700-739 credit score: 7% interest rate
• 680-699 credit score: 8% interest rate
• 660-679 credit score: 10% interest rate
• 640-659 credit score: 12% interest rate
• 620-639 credit score: 15% interest rate

As you can see, having a higher credit score can potentially save you thousands of dollars in interest charges over the loan’s term.

Prior to applying, get a free copy of your credit reports and FICO or VantageScore from AnnualCreditReport.com. Verify all information is correct and your scores from the three bureaus meet minimum requirements. If not, take steps to improve your credit before submitting an application.

Minimum Home Equity Requirements

To qualify for a home equity loan, lenders want to see you have at least 20% equity in your property. Some may permit 15-20% equity with strong credit scores and debt ratios.

Equity is calculated by taking your home’s current market value and subtracting any mortgage debt still owed on the property. For example:

• Home market value: $300,000
• Mortgage debt: $200,000
• Equity calculation: $300,000 – $200,000 = $100,000
• Equity percentage: $100,000 / $300,000 = 33%

In this scenario, you have 33% equity, making you an excellent candidate for a home equity loan. The more equity you have, the lower the risk for lenders.

If your equity is currently less than 20%, you may need to make a larger downpayment on your home equity loan to reach at least 20% equity.

Debt-to-Income Ratio Benchmarks

Lenders analyze your debt-to-income (DTI) ratio to measure your current debt load. DTI looks at your total monthly debt payments in relation to your monthly pre-tax income.

Most lenders cap DTI for home equity loans at 43%. By keeping your DTI at 43% or lower, it demonstrates you have the capacity to take on the additional loan payment.

You can calculate your DTI by adding up all your monthly debt payments, including:

• Mortgage
• Credit cards
• Student loans
• Auto loans
• Personal loans
• Child support
• Alimony

Divide this number by your total monthly gross income. For example, if your monthly debt payments total $2,000 and your gross monthly income is $5,000, your DTI is 40% ($2,000 / $5,000 = 0.40).

If your DTI already exceeds 43%, paying down debts or increasing your income could help you qualify for a home equity loan.

Documenting Sufficient Income

Lenders want assurance you have steady income to repay the loan. At minimum, you’ll need to provide recent pay stubs spanning one month and your W-2 and tax returns for the last two years. Self-employed borrowers may need to provide even more documentation, including business tax returns and bank statements.

There are no set income requirements for home equity loans, but clearly you need adequate earnings to support the new monthly payment while staying within the 43% DTI threshold. Higher income helps keep your DTI ratio lower.

Make sure to disclose all your income sources, such as salaries, bonuses, commissions, interest, dividends, and rental income. The more income you can verify, the larger the loan amount you can potentially qualify for.

Mortgage Payment History

As part of underwriting, lenders will closely evaluate your mortgage payment history. On-time payments indicate you’re a responsible borrower who can manage added debt.

Most lenders want to see a clean record with no late mortgage payments, bankruptcies, or foreclosures in the past 12 to 24 months. Paying your mortgage on time consistently over a long timeframe improves your chances of approval.

If you’ve missed payments, getting current on your mortgage and establishing a timely payment pattern again will help strengthen your home equity loan application. Significant blemishes like a previous foreclosure could require you to wait several years before qualifying.

Finding the Best Home Equity Loan Lender

While the above represent standard requirements across lenders, each financial institution can set their own precise underwriting policies. Shopping around helps find the lender with the credit requirements best matched to your financial profile.

Reach out to multiple lenders to compare:

• Minimum credit score
• Minimum equity
• Maximum DTI
• Mortgage history policies
• Income documentation needed

Meeting a lender’s eligibility criteria is just the first step. You also want to secure the most competitive loan offer in terms of lowest rates and costs. Be sure to compare loan estimates from multiple lenders before committing.

Improving Your Chances of Approval

If your credit doesn’t meet minimum requirements right now, here are some tips to improve your approval odds:

• Pay down revolving debts to lower your DTI.
• Maintain on-time payment history.
• Limit new credit applications.
• Build your credit history by becoming an authorized user on someone else’s account.
• Have co-borrowers with better credit apply with you.
• Make a larger down payment to reach 20% equity.
• Provide more income documentation.
• Explain past credit issues in your loan application.

Meeting lender credit requirements for home equity loans gives you access to lower rates and costs. By understanding these key eligibility factors, you can take the right steps to qualify before submitting an application.