Home equity loans allow homeowners to tap into the equity they’ve built in their homes and use the funds however they choose.
To get a home equity loan borrowers must apply for the loan with a lender, such as Compass Mortgage, and meet certain requirements.
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If these requirements are sufficiently met, the borrower receives a lump sum payment that they repay over a set period of time.
Let’s take a look at current home equity loan requirements, how these loans work and the difference between home equity loans and home equity lines of credit (or HELOCs).
What is a home equity loan?
Home equity loans help borrowers access their home’s equity.
Home equity is the percentage of your home that you own. You can calculate your home equity by subtracting the amount you owe on your mortgage from the current value of the home.
For example, if your home’s value is $300,000 and your mortgage balance is $200,000, you have $100,000 of equity.
However, borrowers can’t access this full amount with a home equity loan. Lenders generally only allow homeowners to borrow up to 85% of the home’s value and require that the owner have at least 20% equity in the home.
Your lender will help you calculate your home equity and how much you’re able to borrow, but to get an idea now you can use an online equity calculator.
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How does a home equity loan work?
The process for obtaining a home equity loan is similar to what you experienced with your existing mortgage.
To get a home equity loan, perform the following steps:
- Apply with a lender
- Provide the required income and employment documentation
- Get your property appraised to confirm the value
- Close on the loan
Once you close on the loan, you receive a lump-sum payment that you’ll repay at a fixed interest rate over a set period of time.
Home equity loans work best if the homeowner is planning to use the funds for a specific purpose, such as home improvement projects or to consolidate debt.
In that case, the borrower will understand the exact amount they need and won’t run the risk of borrowing too much or too little.
General home equity loan requirements
Each lender will have slightly different home equity loan requirements. However, there are some general guidelines borrowers can follow to get an idea of what to expect and how to prepare.
For example, a borrower must have a certain percentage of equity in their home and a good credit score. Let’s take a look at what these general requirements entail.
Home equity of at least 15% to 20%
Most lenders require borrowers to have at least 15% to 20% equity in their homes.
At 15%, a homeowner could borrow up to 85% of the home’s value. 80% would be the maximum that could be borrowed if 20% is the requirement for equity.
Keep in mind that the actual loan amount will be 80% to 85% of the home’s value, minus what is owed on the mortgage.
For example, if your home’s value is $300,000 and your balance is $200,000, you could borrow up to $55,000 at 85%.
Credit score of 630 or higher
According to the FICO credit score model, a “good” credit score is in the 670 to 739 range. However, lenders generally allow credit scores of 630 or higher.
A higher score usually means access to better interest rates, so try to raise your score as much as possible prior to applying for a loan.
Debt-to-income ratio at or below 45%
Debt-to-income ratio (DTI) shows lenders how much you earn each month in comparison with how much of these earnings goes toward your monthly debts.
To calculate your DTI, add up all your monthly bills and divide the total by your gross monthly income. The lower your DTI, the better.
Income and employment verification and history
To qualify for a home equity loan, a borrower must be able to provide proof of income along with employment documentation and history.
Documentation which verifies employment and income helps prove to lenders that the borrower has the capability to repay the loan.
In addition to these requirements, a lender may require an appraisal to confirm the current value of the home and the amount available to borrow.
Whats the difference between home equity loan vs home equity line of credit?
Home equity loans and home equity lines of credit (or HELOCs) both allow homeowners to access their home’s equity in cash. Both allow borrowers to use the funds however they choose.
However, while a home equity loan gives borrowers a single lump sum, HELOCs operate more like a credit card.
Instead of a lump sum, you only borrow what you need, then pay it off and borrow again. You still have a total loan amount, like a home equity loan, but you access it differently.
As a result, HELOCs are considered a more flexible loan option than a home equity loan.
The other main difference is the interest rates: HELOCs generally have adjustable rates, while home equity loans have fixed rates.
Adjustable rates usually begin with a lower introductory rate; but after the introductory period, they rise and fall over time, depending on market conditions.
Fluctuating rates can make payments more unpredictable than the consistent fixed rates which accompany a home equity loan.
As with any loan scenario, the borrower must weigh the pros and cons of each type based on their own unique goals and plans.
Are the requirements the same for a HELOC?
The requirements for a HELOC and home equity loan are generally the same. You will have to apply for either type of loan with a lender, then qualify for the loan based on certain credit score, equity, income and debt requirements.
How to build home equity
There are two main ways to build home equity:
- Regular, on-time, monthly mortgage payments
- Home appreciation (increase in value)
Property values can go up or down over time, but the national average for home appreciation is 3% per year.
Certain home improvements can also increase your home’s value, so it is doubly beneficial if you use your home equity loan to put money back into your home with improvements or renovations.
Apply for a home equity loan today with Compass Mortgage
Connect with an experienced lending professional at Compass Mortgage today to apply for your home equity loan or ask us questions about the process.
Compass Mortgage approaches the lending process differently: We treat you like family, and promise to be your partner and advocate throughout every step.
Together, we will find the most affordable loan for your home, backed by the convenience and power of technology.
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