It may be possible to get a home equity loan if you have high credit card debt, but it’s also possible that your debt could disqualify you. If you do qualify, your lender may charge a higher rate of interest based on your credit card balances.
Its possible to qualify for a home equity loan if you have high credit card debt, but if you do qualify, you might not get the best available interest rate and fees on the loan. Thats because heavy credit card debt can diminish your perceived creditworthiness by elevating your debt-to-income ratio (DTI) and lowering your credit scores. Heres a rundown on what you should know.
Having a high debt-to-income (DTI) ratio can make it challenging to qualify for a home equity loan. Your DTI compares your total monthly debt payments to your gross monthly income Most lenders prefer to see your DTI at 43% or less when applying for a home equity loan
But don’t lose hope if your DTI is higher than that. With the right strategy, you can still get approved for home equity financing even with a high DTI ratio. Here are some tips to improve your chances
Calculate Your DTI Ratio
The first step is to calculate your DTI so you know exactly where you stand. To do this:
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Add up all of your monthly debt payments like credit cards, student loans, auto loans, mortgage, etc Do not include living expenses like groceries and utilities.
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Divide this total by your gross (pre-tax) monthly income.
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The result is your DTI expressed as a percentage. For example, $2,000 in monthly debt payments divided by $5,000 in monthly income equals a DTI of 40%.
Knowing your DTI allows you to target an ideal ratio to improve your approval odds. Shoot for 36% DTI or lower if possible.
Pay Down Revolving Balances
An easy way to quickly lower your DTI is paying down credit card and other revolving balances. This reduces the required monthly payments that count against your DTI.
Target accounts with the highest balances and interest rates first. Pay more than the minimum due on these debts each month to slash the balances faster.
Increase Your Income
Another tactic is boosting your income to improve your debt-to-income ratio. Options include:
- Asking for a raise at your current job
- Finding a higher paying job
- Taking on a side gig for extra cash
- Having a spouse or partner contribute income
Add up all sources of income from jobs, investments, pensions, social security, child support, etc. More total income makes your DTI ratio more favorable.
Get a Co-borrower
Adding a co-borrower to your home equity loan application can offset a high DTI. Their income gets factored in to strengthen the debt-to-income ratio you present to lenders.
A spouse or partner living in your home is an ideal co-borrower. But you can also ask a family member or even renter to co-sign the loan with you.
Just keep in mind, co-borrowers share responsibility for repaying the loan. Make sure they can afford the payments if you can’t cover it someday.
Ask Lenders About Compensating Factors
If your DTI is still high after taking these steps, ask lenders if they will consider your application based on “compensating factors.” These are strengths in your financial profile that help offset a high DTI.
For example, a high credit score, significant home equity, sizable retirement savings, past history of on-time payments, and stable employment are potential compensating factors.
Emphasize these strengths to lenders when applying for a home equity loan with DTI above 43%. It may convince them to approve you despite the high debt ratio.
Compare Loan Types
Certain types of home equity financing may offer more leeway on DTI requirements than others. Compare options to choose the loan most likely to approve you.
Home equity loans provide lump sum cash upfront at a fixed rate and term. You immediately receive and repay the full loan amount. Monthly payments are predictable.
Home equity lines of credit (HELOCs) work more like a credit card. You’re approved for a revolving line of credit secured by home equity and can access funds as needed. HELOCs often have variable interest rates.
In general, HELOCs allow higher DTI ratios than fixed home equity loans. Shop around to find a lender with the most lenient requirements for your financial situation.
Use a Portfolio Lender
Big banks and lenders adhering to Fannie Mae and Freddie Mac guidelines tend to enforce strict DTI limits. For more flexible requirements, consider a portfolio lender instead.
Portfolio lenders fund home equity loans with their own capital. They can set their own underwriting standards and may be open to higher DTIs. Lead generation sites can help you find and compare portfolio lenders.
Federal Housing Administration (FHA)
FHA home equity loans and reverse mortgages are government-insured options that permit higher debt ratios. They require as little as 3.5% down and allow DTIs up to 55%.
These loans have limits on eligibility, loan amounts, and upfront mortgage insurance premiums. But FHA programs provide home financing even with very high DTIs.
Use Home Equity for Debt Consolidation
If other debts like credit cards and auto loans are inflating your DTI, a home equity loan can help. You can use the loan proceeds to pay off those balances in a strategic debt consolidation.
This reduces the number of monthly payments you have to make. Your DTI should improve as you shift unsecured debts to the lower fixed interest rate of a secured home equity loan.
Just be very cautious about taking cash out against your home to pay other debts. Make sure you can afford the higher monthly mortgage payment and potential risk of foreclosure if you default.
Seek Pre-Approval and Shop Around
Applying for pre-approval from multiple lenders allows you to compare offers and identify the best financing options available to you. The pre-approval process involves a soft credit check that does not hurt your scores.
Each lender will evaluate your DTI differently in relation to other factors in your loan application. If one lender denies you due to a high DTI, another may still approve your application. So cast a wide net and get pre-approved by as many lenders as possible.
This shopping around strategy allows you to find the lender most likely to approve your home equity loan or HELOC with a high DTI ratio. The pre-approval also shows sellers you are qualified when making an offer on a home (if using loan proceeds for a home purchase).
Provide Documentation Up Front
Come prepared with documentation to verify your financial information when seeking pre-approval or applying for a home equity loan. This includes:
- Tax returns and W-2s proving your income
- Bank statements showing regular deposits and balances
- Documentation of any extra income sources
- Minimum monthly payment amounts for all debts
Providing all the paperwork upfront rather than waiting for lender requests speeds up the approval process. Submitting required documents with your initial application strengthens your case and avoids financing delays.
Improve Your Credit Score
Work on boosting your credit score in the months prior to needing a home equity loan. Good credit can help offset a high DTI when applying.
Tips to increase your scores include:
- Pay all bills on time
- Pay down card balances
- Limit new credit applications
- Correct errors on your credit reports
- Keep old accounts open
Shop for credit cards and loans within a short window so multiple hard inquiries get counted as one inquiry. Improving your credit score before applying for home equity financing expands your options.
Offer a Higher Down Payment
Another potential strategy is making a larger down payment on the home you want to purchase with the home equity loan proceeds. This allows you to qualify for a smaller loan amount to lower the monthly mortgage payments that impact your DTI.
Of course this requires having cash on hand to put down if your equity financing will not cover the full purchase price. Discuss down payment options with your loan officer when seeking pre-approval for a home purchase loan with high DTI.
Seek Down Payment Assistance
Beyond your own funds, look into down payment assistance programs offered by nonprofits, employers, states and local governments. These programs provide grants, forgivable loans or second mortgages to cover down payments and closing costs.
Down payment assistance paired with a home equity loan allows you to buy a home with less borrowed, keeping payments lower so your DTI qualifies. Be sure to research available options based on your location, income limits and eligibility requirements.
Adjust Your Home Price Range
Pre-approval from your lender will tell you the maximum home equity loan amount you qualify for based on your DTI and other factors. If the financing is not sufficient for your desired home price range, you may need to consider less expensive homes to make the payments work within your allowed DTI limits.
Crunching the numbers on projected monthly payments at different home prices gives you an affordable range to target in your home search. This prevents wasted time looking at properties requiring a larger loan than you can realistically get approved for.
Make Additional Principal Payments
Once you have a home equity loan or HELOC, making additional principal payments above the regular monthly payments can pay the balance down faster. This helps improve your DTI more quickly so you can potentially qualify to refinance the loan on better terms in the future.
Even paying an extra $50 or $100 each month toward principal on a home equity loan knocks years off the repayment timeline and interest costs. Setup automatic payments for a set extra principal amount each month.
Use Cash-Out Refinancing
How Does a Home Equity Loan Work?
A home equity loan allows you to borrow roughly 75% to 85% of the equity you have in your house—the percentage of the house you own outright, or the difference between the houses market value and the amount you still owe on your original mortgage.
If your house is worth $420,000 and you owe $230,000 on your mortgage, your equity is $190,000 or 29%—so you may be able to borrow as much as $140,000 to $160,000 against it. If your original mortgage is paid in full, you have 100% home equity and can borrow against its full market value.
A home equity loan is a type of second mortgage, which means it uses your house as collateral. That also means if you fail to repay the loan, the lender can foreclose on the house.
When you apply for a home equity loan, much as when you apply for a primary mortgage, the lender will scrutinize both you and your house. Theyll want to confirm the value of the house via a home appraisal, to determine your equity stake, which in turn determines the maximum amount you can borrow. Theyll also evaluate you for creditworthiness—your ability to repay the loan and your track record of debt management. Thats where credit card debt could have an effect on your loan approval.
Is Credit Card Debt a Factor With Home Equity Loans?
Yes, high credit card debt can hinder your ability to qualify for a home equity loan. And if you do qualify for a loan, it can mean significant additional interest costs. High credit card debt can influence your home equity loan application in the following ways:
High credit card balances generally mean high minimum payment requirements on your credit cards, and that inflates your debt-to-income ratio—the percentage of your monthly pretax income required to pay your debts. Home equity lenders typically require DTI ratios of 43% or less.
You can calculate your DTI ratio by dividing your gross monthly pay by the sum of your minimum monthly payments on loans, credit cards and other consumer debt, then multiplying by 100 to get a percentage.
For example, if your monthly gross income is $7,200 and your monthly debts include a $2,200 payment on your primary mortgage, a $400 car payment and three credit cards with minimum required payments of $100, $200 and $250, heres how to calculate your DTI:
- Add up your monthly debts. $2,200 + $400 + $100 + $200 + $250 = $3,150
- Divide your monthly debt total by your monthly gross income. $3,150 / $7,200 = 0.438
- Multiply the result by 100 to get a percentage. 0.438 x 100 = 44%
If you pay down the two cards with the highest balances so that their minimum monthly payments are reduced to $100 each, your DTI ratio would change to $2,900/$7,200, or 40%. That could make the difference between qualifying for a home equity loan and having your application declined.
Large amounts of credit card debt typically mean youre using a large portion of your cards credit limits, and that can lower your credit scores. Your credit utilization rate—the balance on a credit card or other revolving account expressed as a percentage of its borrowing limit—is a significant influence on credit scores, and utilization rates that exceed about 30% tend to lower your credit scores.
Most home equity lenders require a FICO® Score☉ of at least 680, and some look for scores of 720 or better. If you narrowly meet these minimum requirements, you may get a loan but, thanks to the practice of risk-based pricing, youll likely be charged a premium interest rate. Lenders reserve their best rates for borrowers with high credit scores, so if high utilization weighs down your scores, it could mean significant interest costs over the life of the loan.
High Debt to Income Ratio Mortgage | Top 4 Options
FAQ
Can I get a home equity loan with a high debt-to-income ratio?
Is it possible to get a loan with a high debt-to-income ratio?
What disqualifies you from getting a home equity loan?
What is too high for debt-to-income ratio?
Can I get a home equity loan with a lot of credit card debt?
Yes, you can get approved for a home equity loan even with a lot of credit card debt as long as your income is high enough and you have sufficient equity in your home. Lenders look at multiple factors when you apply for a home equity loan, such as: Typically wanting a combined loan-to-value (CLTV) ratio of 85% or less.
What is a good debt-to-income ratio for a home equity loan?
When you apply for a home equity loan, lenders will look at your debt-to-income (DTI) ratio as one measure of your ability to repay. Your debt-to-income ratio compares all of your regular monthly loan and credit card payments to your gross monthly income. Many lenders will want to see a DTI of less than 43%. What Is a Home Equity Loan?
Can you get a home equity loan?
You can get a home equity loan or a home equity line of credit (HELOC). Home equity loans are second mortgages that allow you to tap into your equity so you can get access to cash. You can also use the cash loan to pay off other higher-interest debts such as credit card debt and possibly student loan debt.
Should you use home equity to consolidate debt?
Here are some of the pros and cons of using home equity to consolidate debt: Pros Interest rates on home equity loans and home equity lines of credit, or HELOCs, are typically lower than those on credit cards. The fixed rates on home equity loans give you predictable payments. You won’t have to give up a low mortgage rate. Cons