A Home Equity Loan (HELOAN) or a Home Equity Line of Credit (HELOC) are great options for homeowners who wish to borrow money. Homeowners can tap into the equity in their homes and get larger loans at lower interest rates than comparable personal loans. Borrowers can use these funds for various purposes like home improvement or to pay off other high-interest debt like credit card or personal loan debt.
How can borrowers ensure that they can qualify for a HELOAN or a HELOC? To determine whether you are eligible for a home equity loan, lenders look at a few key numbers. There are some simple requirements that borrowers can familiarize themselves with to qualify for a home equity loan.
1. Home Equity
Home Equity is the most useful measure to determine if you are eligible for a Home Equity Loan. A positive home equity amount will allow you to borrow against your home. The amount of home equity will be used to calculate the size of the loan that you may be eligible for.
Home equity is calculated as: (value of the home) – (unpaid mortgage amount)
The easiest way to calculate your home equity is to estimate the value of your home and then subtract your unpaid mortgage amount. E.g. if your home is worth $500k and your mortgage has been paid down from $400k to $350K, your home equity is $500k – $350k = $150k.
Your home price may have changed since you purchased it. Websites like Zillow and Trulia can provide a more up-to-date estimate of the value of your home. Lenders may require an appraisal of your home to determine the most accurate home value. You will need to have positive home equity to be eligible for a HELOAN or a HELOC.
2. Combined Loan-to-Value Ratio
Combined Loan-to-Value Ratio, also known as (CLTV), is one of the most important numbers that a lender will look at before extending a HELOAN. CLTV is equal to the sum of your unpaid mortgage amount and your potential HELOAN, divided by the value of your home.
CLTV is calculated as: (unpaid mortgage amount + HELOAN) / (value of home)
In our example, if the borrower were to take a HELOAN of $100k, his CLTV would be ($350k + $100k) / $500k = 90%.
Lenders usually target CLTVs of between 60% and 100%, although bank lenders would rarely exceed CLTVs of 85%. Newer lenders like Button Finance can help you avail of larger loans of up to 97% CLTV.
3. Debt-to-Income Ratio
Another important consideration is your debt-to-income ratio. A debt-to-income ratio, also known as DTI, is simply the sum of your principal and interest payments divided by your income. Payments include those made on your current mortgage, credit cards, car loans among others.
You should calculate your total monthly payments on all your loans and then divide them by your monthly salary. E.g. if your monthly debt payments are $1,500 and your monthly salary is $5,000, your DTI is $1,500 / $5,000 = 30%.
You can usually include your spouse’s salary in your DTI calculations. Most couples apply for HELOANs together, so including your spouse’s salary will help reduce your DTI.
The lender will calculate a new DTI after including monthly payments for your HELOAN. In this example, if the monthly payments on your HELOAN is $500, your new DTI will be ($1,500 + $500) / $5,000 = 40%.
You should aim to maintain your total DTI after including payments on the HELOAN below 50%. Most lenders will not approve borrowers with DTIs above 40%. Button Finance will allow you to borrow with payments of up to 50% DTI for larger loan sizes.
4. Credit Score
Lenders will also look at your credit score before extending a loan. A good credit score will certainly ease your path to getting a HELOAN.
You can request to see your credit report for free by contacting credit bureaus like Equifax, Experian, and TransUnion. You should check your credit report to ensure that there are no errors and that your credit score is correct. In case of an error on your credit report, you should contact the credit bureau to have them fix it before you apply for a HELOAN.
Most banks will only lend to borrowers who have credit scores above 720. Button Finance aims to lend to borrowers with credit scores above 640.
5. Other Factors to Consider
Some other things to keep in mind before applying for a HELOAN are that lenders will require you to provide documents to prove your homeownership, mortgage, and income. You should have documents showing the title to your home, mortgage deed, home insurance along with your W2s, pay stubs, and tax records.
It is also important to check your credit report for bankruptcies and recent delinquencies among other things and to correct them if they are erroneously reported. Lenders will also look for any other significant expenses that you may have and employment history to determine the stability of your income.
A Fresh Way to Borrow against your Home Equity
If you are considering a Home Equity Loan or Line of Credit, why not look at Button Finance. Button Finance is launching soon – a smart, seamless and convenient way to borrow. Button Finance’s Home Equity Loans will feature an easy, digital application process and quick approval. Unlike traditional lenders, Button Finance will approve qualified applications in a short period of time and you can receive your funds in as soon as 5 days!