Home equity lines of credit, or HELOCs, are a convenient and affordable way to get the money you need for necessary repairs and improvements. In many cases, they can be more affordable than a second mortgage because they work as a revolving line of credit. You borrow only what you need and pay interest only on what you’ve borrowed.
As you might expect, there are requirements to qualify for a HELOC. There are three major things you’ll need to have to get one. Here’s what you need to know.
#1: Equity in Your Home
It should come as no surprise that the first requirement is equity in your home. Equity is defined as the difference between the value of your home and the balance owed on your mortgage. Your equity in your home is what acts as collateral for your mortgage.
Different lenders have different requirements, but you should assume that you’ll need equity worth, at minimum, 20% of your home’s value to qualify for a HELOC. If you apply for a HELOC, your bank or credit union will order an appraisal to determine the value of your home equity.
#2: Personal Credit Score
Next, you’ll need a good FICO score to be approved for a HELOC. Your FICO score is a number that tells lenders how responsibly you handle money. As a rule, a score of 660 or higher indicates good credit, and that number is often used as a cut-off for lenders.
Your FICO score is determined by five key factors. In order of importance, they are:
1. Your payment history accounts for 35% of your score. If you pay on time or early, you’ll likely have a higher score than someone with a history of late payments.
2. Your credit balance accounts for 30% of your score. The score is determined using both your total balance and your outstanding balance as a percentage of your total available credit. If you regularly use most of the credit you have, your score will be lower than it would if you used a smaller percentage of it.
3. The age of your credit accounts for 15% of your FICO score. People who have a long credit history usually have scores that are higher than those with a short credit history.
4. The kinds of credit you have account for 10% of your score. It’s common for creditors to prefer a mix of revolving credit (credit cards and lines of credit) and installment credit (car loans and mortgages.)
5. The number of inquiries on your account make up the last 10% of your score. When you apply for a loan or credit card, your credit score dips slightly. If you have many inquiries in a short period, your score can be significantly impacted.
Keep in mind that the single most important factor is your payment history, and HELOC lenders will look at that section of your credit report closely.
You can get free credit reports from the main credit bureaus every year. It’s a good idea to check your credit before you apply for a HELOC, so you can correct errors before your lenders pulls your report.
#3: Your Debt-to-Income Ratio
The third factor that will determine if you can quality for a HELOC is something called the debt-to-income ratio. Simply stated, it’s a number that lenders use to compare your total recurring monthly debt to your monthly income.
For example, let’s say that your monthly income before taxes was $5,000. You have monthly payments as follows:
1. $1,500 mortgage payment
2. $500 car payment
3. $500 for credit cards and student loan payments
Your total recurring monthly debt is $2,000. If you divide that number by your income, you’ll see that you have a debt-to-income ratio of 40%.
It won’t surprise you to learn that having a low debt-to-income ratio is desirable. Your lender wants to know that you have the income to meet your financial responsibilities. A good rule of thumb is that the ratio should be less than 43% to qualify for a HELOC. If it’s higher, you should consider paying down some of your debt before you apply.
If you’re thinking of apply for a HELOC, checking your home equity, FICO score, and debt-to-income ratio can help you qualify.
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