Do you need funds for a costly home repair, college tuition, or other major expenses? Consider a home equity loan, which provides a lump sum based on your home’s value.
What is a home equity loan?
A home equity loan, considered a second mortgage, allows you to borrow against your home’s value. Similar to your primary mortgage, it’s repaid in monthly installments. With your home as collateral, lenders often offer lower interest rates due to the security of foreclosure in case of default.
How to qualify for a home equity loan?
Before you consider applying for a home equity loan, it is a good idea to understand the basic requirements. While not all lenders have the same standards when it comes to qualifying for a home equity loan, the following are common home equity loan requirements.
- A minimum of 15 to 20 percent equity in your home.
- A minimum credit score of 621.
- A maximum debt-to-income (DTI) ratio of 43 percent.
- A history of on-time bill payments.
- Stable employment and verifiable income history.
Home equity loan denial is often out of your hands
Even with a good credit score and stable income, there’s a possibility of being denied a home equity loan. Since the COVID-19 pandemic, banks have become even more cautious, with some halting approvals altogether. The uncertain economic climate has led to increased reluctance among banks to issue home equity loans as freely as before. As the economy stabilizes post-pandemic, home equity loan approval rates are expected to return to pre-pandemic levels.
Common causes for a home equity loan denial
Low home equity
Your home equity represents the portion of your home’s value that you own outright. It’s calculated based on the current appraised value of your home, not the original loan amount. To determine your home equity:
- Subtract the outstanding balance of your loan from the current appraised value of your home.
- For instance, if your home is appraised at $300,000 and you owe $200,000 on your loan, your home equity would be $100,000.
- To find the percentage of your home equity, divide the calculated home equity by the appraised value. In this example, $100,000 divided by $300,000 equals 0.33, or 33%.
This calculation helps you understand how much of your home you truly own and can potentially leverage through means like a home equity loan.
Credit score below 620
While a low credit score isn’t necessarily an automatic disqualifier for a home equity loan, it does play a significant role in the lender’s decision-making process. Each lender has its own set of minimum requirements, but typically, a credit score of at least 620 is preferred for approval.
DTI is too high
DTI, or debt-to-income ratio, represents the portion of your gross monthly income allocated to debt payments. While specific thresholds may vary among lenders, typically, a DTI of under 43% to 50% is considered favorable for loan consideration.
Unstable income source
A steady income source is one of the main ways a lender determines your creditworthiness. While most don’t have a stated income level they are looking for, if you are unable to show steady income through employment, investments, or spousal support, it’s unlikely a lender will approve your application. They need to know you will be able to make regular payments and spotty income history is prohibitive.
Poor payment history
In addition to assessing your credit and income, lenders also scrutinize your payment history on rent, loans, or mortgages. They seek a track record of timely payments and absence of defaults, which serves as an indicator of your reliability in meeting future payment obligations.
History of foreclosure or bankruptcy
Bankruptcy or foreclosure entries typically persist on your credit report for a minimum of six years. Even if you’ve made significant progress in rebuilding your credit score after bankruptcy, lenders may hesitate to approve a home equity loan while these negative marks remain on your report.
My home equity loan was denied, now what?
If your home equity application is declined, don’t lose hope. Before reapplying, take proactive steps, starting with discussing with your lender the reasons for the denial, as they are obligated to provide this information. Use this insight to evaluate your finances and implement necessary changes to enhance your eligibility for future applications.
Some adjustments can yield immediate improvements, while others may require more time to take effect. Regardless, persistence and strategic financial management can ultimately increase your chances of success.
Short-term strategies to tackle home equity loan
You can take certain steps to facilitate the advancement of your loan. Among the short-term tactics are:
Large down payment
Making a larger down payment of 15% to 20% on a home purchase automatically provides you with that much equity in the property. Beyond this immediate benefit, a larger down payment lowers your monthly payments and improves your debt-to-income ratio (DTI). This financial profile appears more attractive to lenders, as it offers increased security against default.
Provide collateral
If possible, offering a high-value asset such as a vacation home, investments, or a business as collateral can strengthen your loan application. However, it’s crucial to weigh this decision carefully, as the collateral becomes the property of the lender if you default on the loan. Therefore, it’s essential to assess the risk and ensure you’re comfortable with the potential consequences before using valuable assets as loan collateral.
Get a co-signer
If your credit is less than optimal or you’re unable to demonstrate sufficient income to meet the required debt-to-income ratio (DTI), you can consider having someone co-sign the equity loan with you. This allows their income and credit to be factored into the calculations, potentially increasing your chances of approval. However, it’s crucial to recognize that co-signers assume responsibility for the loan and its repayment if you fail to meet your obligations. Therefore, it’s essential to carefully consider this option and ensure both parties understand the associated risks before proceeding.
Long-term strategies
If you aren’t on a tight timeline for a home equity loan, there are some long-term strategies that you could try. These include:
Boost your credit
Boosting your credit can improve your chances of qualifying for a home equity loan. Here are some steps you can take to boost your credit:
- Check your credit report for errors and dispute any inaccuracies.
- Pay your bills on time to establish a positive payment history.
- Reduce your credit card balances to lower your credit utilization ratio.
- Avoid opening multiple new credit accounts within a short period.
- Consider becoming an authorized user on someone else’s credit card to benefit from their positive payment history.
- Keep older accounts open to maintain a longer credit history.
- Use credit responsibly and avoid maxing out your credit cards.
- Consider credit-building tools like secured credit cards or credit builder loans.
By following these steps, you can gradually improve your credit score and increase your chances of qualifying for a home equity loan.
Improve your income
Increasing your income can positively impact your debt-to-income (DTI) ratio and improve your eligibility for a home equity loan. Here are some ways to boost your income:
- Position yourself for a promotion at your current job by demonstrating dedication and seeking opportunities for advancement.
- Consider taking on a side gig such as driving for Uber, delivering with DoorDash, or freelancing in your spare time.
- Explore job opportunities that offer higher pay or better benefits.
- Invest in your education or acquire new skills to qualify for higher-paying positions.
- Negotiate a salary raise or seek additional compensation for your contributions to your current employer.
By increasing your income through these avenues, you can improve your financial standing and enhance your chances of qualifying for a home equity loan.
