What Are the General HELOC Requirements?
A HELOC, or Home Equity Line of Credit, is a loan that is taken out against the available equity on your home. This is where its name comes from. These loans are great for paying off high-interest loans (especially since their rates are usually a few percentage points over the federal rate), paying for home remodeling jobs, and many other things. They are incredibly useful – as long as you qualify for one. Here’s what the general HELOC requirements are.
You Must Have Equity in Your Home
Obviously, since the name of the loan has the words “home equity” in it, this makes plenty of sense. But what is equity? How do you know if you have some? The first of these two questions are easy to answer, although you’ll need to see a lender in order find a response to the second.
Equity is the amount of money that you have available on your home. It’s technically how much of the cost of your home is open to being borrowed against. This is best explained with an example scenario. If you have a house that’s worth $150,000 and your current mortgage is only for $75,000 of that amount, then you have $75,000 available in equity. The amount is based on how much your house is worth, not what your original mortgage was, so you might only have paid $100,000 for your home. It’s worth went up (or you received a great deal on it) so you have that equity available.
This doesn’t mean that you’ll be able to take a HELOC for that entire $75,000. There are other factors involved in that. We’ll get to them in a minute. What you do need to know is the general process for determining your equity. It all starts with a visit to a lender. The lender will look up the loans that you currently have against your home – all of your mortgages, first, second, and so on – and then add them up. That amount is compared to how much your home is worth in order to determine your equity.
If you don’t have any equity due to a very large mortgage or even a house that’s lost it’s worth for any reason, then you won’t be able to take out a HELOC. You’ll have to find some other option. Your lender will go over all of that with you.
Your Credit Rating Must Be Good
Once it’s been determined that you do have equity available in your home for a HELOC, then you’ll need to fill out an application and allow the lender to pull your credit history and score. This is one of the most important HELOC requirements. Many lenders won’t approve you for a HELOC if your FICO score is lower than 680. Of course, those with a higher score are much more likely to be approved, as long as their debt to income ratio is acceptable. This is the second piece of the puzzle.
A debt to income ratio looks at the number of debts that you have and then compares it to your income. Ideally, you’ll have a ratio that is no higher than 40 to 45%. This means that you’ll have monthly debts that equal no more than 40 to 45% of your take-home pay. Look at it this way – if you make $5,000 per month and have debts that are around $2,000, then you’re ratio will be good enough to qualify for a HELOC. The lender needs to make sure that you’ll be able to make those interest and principal payments.
With that said, both the credit rating score and the debt to income ratio are examined closely. They usually match up well, as people with a good credit rating tend to have a low debt to income ratio because they can afford to pay their bills in full each month. This isn’t always the case though, and lenders see people with a low credit score and a good debt to income ratio, as well as the opposite - a great credit score and low ratio. It all depends on how the lender weighs each of the factors.
If you want to take out a HELOC and are worried about these numbers, then you’ll need to do a little detective work before you head to your lender. You can determine exactly how much you owe on your mortgage (or mortgages) and how much your home is worth in order to find out if you have equity. You can also pay off any revolving debt, like credit cards, and then wait a month for the reporting cycle to refresh. Then, you can head to your lender armed with the knowledge that you have enough equity, a good credit rating, and a low debt to income ratio.