Requirements for a Home Equity Loan or HELOC

Requirements for a Home Equity Loan or HELOC

Consider the pros and cons of home equity loans and HELOCs and how they align with your needs to help you determine if either is a good fit for you. Whether you decide on a home equity loan or HELOC, you'll need to meet specific criteria to qualify, and those requirements can vary from one lender to the next.

Here are the typical requirements for home equity loans and HELOCs:

1. Sufficient Equity in Your Home

Generally, lenders require a minimum of 15% to 20% equity in your home. Home equity is the amount of your home you own outright. In other words, it's the difference between your home's current value and the amount you owe on your mortgage.

Example: If your home value is $500,000 and you owe $400,000 on the mortgage, you have $100,000, or 20%, in home equity.

While there are many ways to build home equity, it typically happens naturally as you make your monthly mortgage payments or when your home value rises.

2. Good Credit

While minimum credit score requirements vary by lender, most look for a FICO^® Score^Θ of at least 680. Some lenders require a minimum credit score of 720, but the higher your score, the better. Other lenders may approve your home equity loan or HELOC with a credit score below 680 if you have substantial equity or income.

Learn more: Can You Get a Home Equity Loan With Bad Credit?

3. Solid Payment History

While your payment history is a factor in your credit score, lenders still want to review your credit report to see how well you manage your debt. Specifically, lenders want to see that you make consistent, on-time payments on all your credit accounts.

Your lender could consider it a risk to extend a loan or line of credit if they see a record of late payments. This concern is especially true with second mortgages like home equity loans and HELOCs, where the lender would be second to recoup their loss if your home ever faces foreclosure.

Learn more: How to Improve Your Payment History

4. Proof of Income

As with most loans, lenders want to verify you have sufficient income to repay a home equity loan or line of credit. They also use your income and other factors to determine your borrowing limit. Before you apply, make sure you have pay stubs, W-2s, tax returns or other types of income verification on hand to prove you have adequate income.

5. Low Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is one of the most important considerations lenders review before making an approval decision. Your DTI measures the amount of your monthly gross income that goes toward your monthly debt obligations. In general, a lower DTI indicates to lenders you're more likely to successfully manage a new loan or credit line than a borrower with a high DTI. Lenders typically prefer a DTI of 43% or less.

6. Proof of Homeowners Insurance

Lenders don't typically approve a loan secured by your home unless you have homeowners insurance. The insurance protects the lender's investment against a financial loss if your home suffers a catastrophic event.

How Do Home Equity Loans and HELOCs Work?

Home equity loans and home equity lines of credit (HELOCs) are two different ways that you may be able to tap into the equity in your home. You could then use that money to fund a home renovation, consolidate debt or cover other expenses.

Both home equity loans and HELOCs are considered second mortgages—separate from your original one—and require you to secure the loan or line of credit with your home. That means the lender can foreclose on your home if you don't repay the debt for any reason. With your house serving as collateral, the lender's risk is reduced, which could help you qualify for a lower interest rate than other credit products like personal loans and credit cards.

Home Equity Loans vs. HELOCs

With a home equity loan, you'll receive a lump-sum payment at closing, which you must repay in monthly payments over a term ranging from five to 30 years. For their part, HELOCs work like credit cards, allowing you to draw money as needed, as often as you like, up to your credit limit.

Here are the primary differences between how home equity loans and HELOCs work.

Alternatives to Home Equity Loans and HELOCs

Home equity loans and HELOCs can be valuable tools to tap into your home equity to consolidate debt or pay for large expenses. Still, other financing options may align better with your specific situation.

Here are some alternatives to home equity loans and HELOCs to consider:

• Cash-out refinance: With a cash-out refinance, you replace your existing mortgage loan with a new, larger one, preferably with a lower interest rate. The new mortgage pays off the old one, and you receive the difference as a lump sum at closing. Cash-out refinances have declined in popularity in recent years amid high mortgage rates.
• Personal loan: Unlike a home equity loan or HELOC, a personal loan is an unsecured debt. That means you don't have to offer your home as collateral to secure the loan. However, the lack of collateral increases the lender's risk, so you'll likely pay higher interest rates than you would with a home equity loan or HELOC. Loan amounts range from a few thousand dollars to $100,000, with repayment terms usually spanning two to five years.
• Personal line of credit: Many banks and credit unions offer personal lines of credit, revolving credit that works much like a credit card. You can borrow money as needed up to your borrowing limit and only pay interest on the amount you borrow. You don't need to put up your home as collateral for the line of credit, though the trade-off is usually higher interest rates. Typically, you receive bank checks or a bank card to make purchases or withdrawals.
• Balance transfer credit card: If your primary goal is to consolidate high-interest debt, a balance transfer credit card may be your best option to combine all your debt into one account. This is especially true if you can repay the debt during the card's introductory 0% APR period, which can last as long as 21 months. However, any remaining balance left over once the introductory period expires will likely incur the card's standard credit card APR, which can be significantly high.

Frequently Asked Questions

Shore Up Your Credit Before Applying

Home equity loans and home equity lines of credit are two options that may help you tap into your home's equity for cash. You may boost your odds of approval by ensuring you meet common requirements, such as having 15% to 20% equity in your home, a DTI ratio below 43%, a solid payment history and verifiable proof of income and homeowners insurance.

Of course, your credit plays a significant role in your chances of approval and the interest rate you receive. You may qualify with a credit score of at least 680, but you may improve your terms with a higher score.

If your credit score is lower than you'd like, consider checking your FICO^® Score and credit report for free from Experian. You'll discover where your credit stands and any potential issues that may be harming your score.