If you’re a homeowner who has paid down a chunk of your mortgage or whose house has gained value, you might be able to take out a loan secured by your home equity. However, having equity in your home isn’t the only requirement to qualify for a home equity loan.
Here’s what you need to know about the requirements for a home equity loan. By understanding the rules of thumb, you can decide if a home equity loan is right for you and prepare accordingly.
Learn more: What is a home equity loan? A complete overview
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Home equity describes the difference between the value of your home and your outstanding mortgage balance. For example, if your home is worth $400,000 and you still owe $300,000, you still owe 75% — meaning you have 25% equity.
A home equity loan is a type of second mortgage that allows you to borrow from the equity you’ve built. It’s a secured loan, so it uses your house as collateral.
Home equity loans typically have fixed interest rates, and the loan proceeds are disbursed as a lump sum. To repay a home equity loan, you’ll make regular monthly payments that are amortized over the repayment term, which can be as long as 30 years.
The amount of money you can access through a home equity loan depends in part on the market value of your home because equity is calculated by subtracting your mortgage balance from the market value.
Dig deeper: How much is your house worth? How to determine your home value.
Borrowers must meet several essential lending criteria to qualify for a home equity loan. While the specific requirements vary from one mortgage lender to another, these are the typical standards you must meet to qualify for a home equity loan:
Most lenders only offer home equity loans to homeowners with at least 15% to 20% equity. For example, let’s say your home is currently worth $400,000, and you owe $350,000 on your mortgage. Most lenders wouldn’t allow you to take a home equity loan because you’ve only accrued $50,000 in equity, which is 12.5%.
A homeowner with a house valued at $400,000 would need at least $60,000 to $80,000 in equity to reach the minimum 15% to 20% required by most lenders.
Also, most lenders won’t allow you to borrow more than 80% of the equity you have built in your home. So, if you have $80,000 worth of equity in your home, your lender will generally cap your home equity loan at $64,000 — or 80% of the $80,000 in equity.
Read more: 7 ways to build equity in your home
Good credit and low debt-to-income ratio
Lenders need to trust that you’ll repay your home equity loan. That’s why they set minimum credit scores and maximum debt-to-income ratios to qualify for this type of second mortgage.
Though credit requirements for home equity loans vary by lender, the typical minimum required credit score is 680. However, an even higher credit score can help you qualify for lower interest rates and better terms.
The debt-to-income ratio (DTI) calculates how much of your monthly income goes toward your mandatory debt payments. Lenders typically prefer a DTI ratio of 43% or less, though some will require a slightly lower or higher ratio. Like having a higher credit score, a lower DTI ratio can increase your chances of qualifying for better home equity loan rates and terms.
Learn more: What is debt-to-income ratio, and how do you calculate it?
You’ll need to verify your income to qualify for a home equity loan. The mortgage lender requires proof that you earn enough to afford the payments on your home equity loan. You may need to provide pay stubs, W-2s, or tax returns to prove your income level.
Dig deeper: What percentage of your income should go toward a mortgage?
Homeowners insurance doesn’t just protect you against an unexpected loss — it also protects your lender in case something happens to your home. This is why mortgage lenders require homeowners to carry appropriate insurance as a loan condition.
It’s the same for home equity loans. To qualify for a home equity loan, you must provide proof of your current homeowners insurance policy. Your insurance policy protects the lender’s investment in your home in case of a disaster.
Read more: What does homeowners insurance cover?
Home equity loans usually require an appraisal to determine the home’s current market value. The home appraisal ensures the mortgage lender knows exactly how much equity you have in the house. That way, the lender can protect itself from loaning a borrower too much money.
Keep learning: How a home appraisal works
Preparing the necessary documentation and information before you start your home equity loan application can make the process easier. Most borrowers will need these documents to apply for a home equity loan:
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Your most recent mortgage statement: This document displays the remaining balance on your primary mortgage.
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Proof of income: This might include your most recent tax return, W-2s, and pay stubs. You’ll also need proof of employment.
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Bank statements: The mortgage lender may want this information to determine your cash reserves before you take on more debt.
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Insurance documentation: The lender will need a copy of your homeowners insurance policy and any hazard or flood policies.
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Identification: Have your Social Security number, driver’s license, or passport on hand.
The lender will also need to see your home appraisal, although the lender usually orders the appraisal after you’ve applied for the loan and received preapproval.
Read more: How to choose between a second mortgage and a refinance
A home equity loan lender could deny your application for various reasons. Lenders might turn down homeowners with insufficient equity, even if they might otherwise qualify. But having enough equity in your home doesn’t guarantee a loan. If your credit history is poor, you have a high debt-to-income ratio, or you can’t prove that you have enough income to repay your loan, a lender might reject your home equity loan application.
Usually, yes — most lenders require an appraisal for a home equity loan because it assesses how much your home is worth, which helps determine how much equity you have. Having an appraisal ensures that neither the lender nor the borrower uses an inflated value to pinpoint the level of equity.
Yes, the term “second mortgage” refers to any new loan you take out using your home as collateral when you already have a first mortgage secured by the home. That means home equity loans and home equity lines of credit (HELOCs) are both types of second mortgages.
This article was edited by Laura Grace Tarpley.
