If you are considering applying for a home equity loan you might wonder if you qualify. When a mortgage lender evaluates your creditworthiness while approving your home equity line or second mortgage, there are three factors evaluated. These factors are your credit history, your income, and the loan-to-value ratio of your home.
Your Credit History
The state of your credit has a major effect on your ability to qualify for a home equity loan and the interest rate you receive. The better your credit, the more options you will have for your home equity loan, including a competitive interest rate. If you have poor credit, you can still qualify for a home equity loan; however, you will pay more for the financing. Before you apply for a home equity loan it is important to carefully review your credit reports and dispute any errors or negative information.
Your Income
The equity in your home is the portion you own. When you borrow against your home, the lender is granting you a loan secured by your equity. The mortgage lender wants to be sure they will get their money back. This is why lenders evaluate your income to determine your ability to repay the loan. To determine your ability to pay back the loan, the mortgage lender calculates your debt-to-income ratio. This ratio expresses how much of your income goes to paying your bills on a monthly basis. Most lenders want this ratio to be less than 38% of your income on a monthly basis.
Your Loan-to-Value Ratio
Assuming the mortgage lender is going to approve your home equity loan, the amount you can borrow is determined by your loan-to-value ratio. This ratio expresses how much you owe on your mortgage versus the value of your home. If a mortgage holder owes $70,000 for a home worth $100,000, this borrower’s loan-to-value ratio is 70%. Most traditional lenders want your loan-to-value ratio below 80%. There are non-traditional lenders that will lend well over 100% of your homes value; however, these loans are risky because they leave you with no equity as a cushion from the economy. You can learn more about your mortgage and home equity choices by registering for our free mortgage guidebook: “Five Things You Need to Know about Your Mortgage.”
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
Thanks for the great tips.