Qualifying for a home equity loan is similar to a mortgage refinance.
A home equity line of credit (HELOC) is a mortgage on a piece of real estate. Most of these accounts are revolving -- like credit cards -- so that consumers can borrow what they need, repay the advance, and re-borrow if necessary. Qualifying for these loans is often quite similar to taking out a mortgage refinance. However, if you obtain a HELOC through your first mortgage lender, the process may be a bit faster.
The main qualification for HELOCs is equity. You must have sufficient equity in the home and you must meet the loan to value ratio as required by your lender. To figure your loan to value (LTV), divide your mortgage balance (including a proposed HELOC) by the appraised value of your home. For example, if you have a first mortgage of $200,000, an equity loan application for $20,000 in the works, and your home is worth $310,000, your LTV would be 71 percent. Most lenders do not like to lend on properties with LTVs above 95 percent.
Debt to Income Ratio
Lenders make sure that borrowers can afford a new monthly mortgage payment. To do this, they use a ratio called Debt to Income (DIR). To figure your DIR, divide your monthly expenses (including a proposed HELOC payment) by your gross monthly income. For example, if you have $1,200 in expenses and $3,000 in gross income, your DIR is 40 percent.
Lenders also want to be sure you can comfortably afford to live after you've paid your mortgages and monthly bills. They confirm this with a disposable income (DI) calculation. To figure your DI, subtract your total monthly expenses from your net monthly income. For example -- continuing with the example above -- if you have $1,200 in expenses and your net income from your $4,000 paycheck is $2,600 (35 percent tax), your disposable income is $1,400. Lenders usually want to see at least $1,000 in disposable income, more if you have children.
Credit qualifications on HELOCs can vary quite dramatically. Generally speaking, the lower your credit rating, the higher the interest rate. Excellent credit scores are 720 and higher. Poor scores are below 600. It would behoove you to improve your credit score before applying for HELOC if you fall below 600. Otherwise, you'll be paying a massive interest rate.
Mortgage Pay History
HELOC lenders pay special attention to secured debt payment history -- especially mortgage history. If you've had some credit problems in the past, but your mortgage history is solid, you may still qualify for a competitive rate. However, if you've had credit problems on credit cards and your mortgage, you may have trouble qualifying for a HELOC.