Home Equity Loan Requirements: What You’ll Need to Qualify
As a homeowner, it can feel like most of your net worth is tied up in your house. A home equity loan can help you free up some of that cash without the need to sell your house.
You must meet home equity loan requirements to qualify, however, which are often more strict than first mortgage requirements. If you’re deciding whether a home equity loan is right for you, let us walk you through what you need to know about qualifying for one.
Home equity loan requirements
The requirements for a home equity loan tend to be stricter than the requirements for a typical first mortgage. The exact rules will vary by lender, but there are three general guidelines that most lenders follow:
1. Debt-to-income ratio: 43% or less
Your debt-to-income (DTI) ratio measures the monthly debt payments you currently make compared to your monthly income. To calculate your DTI ratio, add up the monthly payments on the loans you have, then divide them by your monthly income before taxes.
For example, let’s say that each month you have a $400 student loan payment, a $300 car payment and an $1,800 mortgage payment. That means you have a debt load of $2,500 a month. Now let’s say you earn $6,250 per month. Your DTI ratio stands at 40%.
To qualify for a home equity loan, your DTI ratio will typically need to be below 43% once your potential new loan payment is factored in. You can lower your DTI ratio by paying off debt or increasing your income.
2. Credit score: At least 620
In many cases, lenders will set a minimum 620 credit score to qualify you for a home equity loan — though the limit can be as high as 660 or 680 in some cases. Still, there are some options for a home equity loan with bad credit.
How to find your credit score
The biggest factor in your credit score is your payment history — so if you need to boost your credit score to qualify for a home equity loan, focus on making your payments on time, every time.
3. Home equity: At least 15%
You need to have a minimum amount of equity — at least 15% — to qualify for a home equity loan. Lenders often express this as a maximum 85% loan-to-value (LTV) ratio. The LTV ratio measures your outstanding mortgage balance against your home’s market value.
Ultimately, the more equity you have, the more money you can borrow. Home equity loans for borrowers with less than 10% equity (which would be an LTV ratio of 90% or higher) are sometimes called high-LTV loans and will likely come with a higher interest rate.
How does a home equity loan work?
The amount you’re able to borrow with a home equity loan is generally set by the amount of equity in your home. You can usually borrow up to 85% of your home’s value, minus your first mortgage balance.
For example, let’s say your home is worth $300,000 and you still owe $100,000 on your first mortgage.
→ 85% of $300,000 is $255,000.
→ Subtract your $100,000 balance from $255,000, and you end up with $155,000.
→ So, you can likely borrow up to $155,000 with a home equity loan.
How you get the money: You’ll receive the money in a single, lump sum.
How you make payments: You’ll immediately begin paying back the money with a monthly payment at a fixed interest rate.
What you’re risking: If you fail to make the payments on your home equity loan, you could lose your home to foreclosure.
Home equity loan rates: What to expect
Home equity loan rates are typically higher than what you’ll find on either a 30-year fixed mortgage or a home equity line of credit (HELOC).
Interest rates have risen over the last year, but our expert’s mortgage rates forecast predicts a slow decline over the coming months — provided that inflation doesn’t climb and the job market remains strong enough to keep the unemployment rate relatively low. While home equity rates aren’t tied directly to the prime rate like HELOC rates are, they do tend to follow the broader rates environment.
See more about current home equity loan rates.
The best place to get a home equity loan
The best home equity loan is one with payments that fit in your budget, has a competitive rate and comes from a lender who will treat you right — but finding that loan isn’t always easy.
Comparison shopping with three to five lenders can save you thousands of dollars in the long run, according to a LendingTree study, so it’s well worth your time. But the only way to save yourself thousands of headaches is to also consider whether potential lenders will provide the experience you need — like sending texts to customer service, having an online application process or accessing a wide network of brick-and-mortar locations.
Unsure where to start? Read our list of the best home equity loan companies of 2023.
Pros and cons of home equity loans
| Pros | Cons |
|---|---|
Lower costs: You’ll spend less just to borrow the money compared to credit cards or personal loans Fixed payments: You'll have fixed monthly payments for the entire loan term Tax benefits: Your loan interest may be tax-deductible Flexibility: You're not restricted in how you use the money Interest rates: Your loan won't be directly affected by rising interest rates like HELOCs | Closing costs: You'll pay substantial closing costs ranging from 2% to 5% of your loan amount Loss of equity: You’ll reduce your available equity as you raise your total debt Foreclosure: You risk foreclosure if you default Tough to qualify: You might have a tougher time qualifying for a home equity loan than your other loan options Isn’t a line of credit: You’ll have less flexibility in how and when you can access funds compared to a HELOC |
Should I get a home equity loan?
You should consider getting a home equity loan if:
→ You want to make home improvements
Home equity loans are commonly used to pay for costly home improvements like renovations and additions. If you use the loan to fix up your home, the interest you pay is usually tax-deductible.
→ You want to pay off higher-interest debt
Since home equity loans are secured by your home, they usually have lower interest rates than you’ll find on unsecured loans, such as credit cards or personal loans. You may be able to consolidate high-interest debt with your new home equity loan, leaving you with a lower interest rate and lower monthly payment.
→ You can afford your mortgage and other monthly expenses
Don’t take out a second mortgage if it’ll break your budget. A home equity loan adds another mandatory monthly payment to your finances, in addition to your existing mortgage payment and any other loan payments you’re responsible for.
Ready to get a home equity loan? Get started today by calculating how much you could borrow.
Alternatives to home equity loans
Cash-out refinance
A cash-out refinance involves taking out a new mortgage that pays off and replaces your current mortgage, but with a higher amount than you currently owe: The difference will come to you as cash. You’ll also pay typical mortgage closing costs.
Advantage: Your interest rate is likely to be lower than what you’d get with a home equity loan, since a cash-out refi is a primary mortgage and not a second one.
Home equity line of credit (HELOC)
A HELOC is another loan product based on your home’s equity, but allows you to withdraw funds over time, up to a set limit. Note, though, that HELOCs typically have variable interest rates, meaning your monthly payment is likely to change over the years while you’re paying it back.
Advantage: You’ll have low monthly payments during the initial draw period and can pay off and re-use the line of credit as much as you want during that time.
Reverse mortgage
With a typical mortgage, you make payments each month to pay back the loan. With a reverse mortgage, a lender pays you in a lump sum or on a monthly basis (or in some cases through a credit line) based on your home equity. The balance isn’t due until you leave the home or die. Reverse mortgages are exclusive to seniors age 62 or older and are often used to supplement retirement income. However, paying off a reverse mortgage often involves selling the home.
Advantage: You won’t have a monthly payment.
Personal loan
Personal loans are a type of installment loan, usually with a fixed interest rate. As with a home equity loan, you receive the proceeds of a personal loan as a lump sum. Personal loans are generally unsecured, meaning there’s no foreclosure risk — but you’ll likely pay a higher interest rate and can be sued if you default on the loan.
Advantage: You aren’t putting your home at risk.
0% APR credit card
If you’re looking for a relatively short-term loan, a 0% APR credit card may be a good option. These credit cards charge zero interest for an introductory period, but the interest rate jumps back to a normal rate after that time. Credit limits will likely be lower than you’d be able to borrow with a home equity loan, though, and interest rates after the introductory period can be steep.
Advantage: You can avoid paying interest if you pay off your balance before the introductory period ends.
CD-secured loan
If you have a significant sum invested in certificates of deposit (CDs) and hit an unexpected financial emergency, you may wish you could access those funds without having to pay early withdrawal fees. CD-secured loans are one way to access a lump sum without actually pulling your money out of the CD. You can usually get a loan for the full amount you’ve invested without paying a high interest rate.
Advantage: You’ll have a plan for emergencies that doesn’t require taking money out of your CDs early.
Balance transfer credit card
If you have strong credit but are carrying high-interest debt, a balance transfer credit card can consolidate your debt and give you a period of up to 21 months to pay down the principal balance without worrying about interest. You’ll usually have to pay a balance transfer fee, but if you can pay down your debt fast enough to match your interest-free introductory period, a balance transfer credit card could save you much of the pain of your high-interest debt.
Advantage: You can buy yourself enough time to significantly reduce high-interest debt without the added interest expense.
Credit counseling
If you’re struggling to stay on top of your debts and expenses, a credit counselor can help. Beyond simply offering advice, credit counselors can assist you as you create and execute a debt management plan. During this process, the counselor may help you get discounts from your creditors on interest rates and fees, or lower your monthly payments.
Advantage: You’ll have help strategically attacking your debt.
Frequently asked questions
To qualify for a home equity loan, you’ll typically need to document your ability to repay the loan. This includes earning enough income to make your payments. If you don’t have a job, you’ll have to show you have enough income from other sources to make your payments.
Every lender operates at its own speed, but since the process to underwrite a home equity loan is similar to a standard mortgage, you can expect it to take about the same amount of time. The average time to close on a home loan is 51 days.
There’s no rule or law to prevent you from getting multiple home equity loans, however, you’ll be limited by your equity. If you took out the maximum amount on your first home equity loan, you may not have enough equity left to support another loan.
Home equity loans are usually offered with loan terms that range from five to 30 years, but the loan term that’s right for you will be largely determined by the monthly payments. If you’re taking out a large amount, you may be able to afford a 30-year loan but be in over your head with a five- or 10-year loan.
How much you can borrow depends on how much home equity you have, your credit score and other factors. A home equity loan calculator can help you estimate how much you might be able to borrow.