What are the requirements for a home equity loan or HELOC?

Your home is more than just a roof over your head. It might also be the cornerstone of a solid financial plan. That's because you could potentially use your home's equity—its value above what you owe—to secure a home equity loan or home equity line of credit (HELOC).

A home equity loan could be bigger and easier to qualify for compared to other kinds of loans. Getting money from your home's equity could help you reach your financial goals. This can include paying off debts, paying for an emergency, fixing up your home, or tackling another priority. 

Let’s talk about what it takes to get a home equity loan.

What are the basic qualifications for a home equity loan or HELOC?

Requirements for a home equity loan or HELOC can vary based on the terms and lender. However, pretty much all home equity lenders will look at the same factors:

• Your debt-to-income ratio (DTI). This is calculated by adding up all of your monthly debt payments and dividing that amount by your gross monthly income (your pre-tax income).

• How much equity you have in your home. Most lenders require you to maintain at least 20% equity in your home even with the home equity loan or HELOC. They often use your combined loan-to-value (CLTV) to determine how much you can borrow.

• Your credit history. Lenders will check your credit reports to see how you handle debt and whether you pay your bills on time. A long history of on-time payments could help show the lender you're low risk.

• Your income and employment history. In addition to using your income to calculate your DTI, lenders will also want to make sure that your income is steady. At least two years of regular employment could help show you have reliable income.

In short, lenders want to know that you can afford any loan you take out and that you are likely to pay it back as agreed. For the longer version, keep reading.

Requirements to get a home equity loan

Why lenders care about debt-to-income ratio (DTI)

Your debt-to-income ratio (DTI) measures your total monthly debt payments, including the home equity loan, against your gross monthly income (your income before taxes).

For example, let's say your gross income is $7,000 per month. The total debt you pay each month toward housing, credit cards, loans, and other debts (like child support or alimony) adds up to $2,800.

By dividing your debts by your gross monthly income, a lender can calculate your DTI at 40%:

$2,800 / $7,000 = 0.40 

0.40 x 100 = 40%

Maximum DTI varies by lender, but most want a DTI below 43%. 

That 43% may seem like a random percentage lenders use, but here’s what it really means: a low DTI indicates your debt amount is manageable and you’re more likely to be able to pay your bills. If your DTI is higher than you'd like, there are two ways to improve it:

• Increase your income. This could be getting a raise, taking on more hours, or adding a side hustle.

• Decrease your debt load. For example, if you pay off a credit card or other debt, your DTI will drop. 

Try an online debt-to-income calculator to crunch the numbers on your DTI. You can also use the calculator to explore your options if your DTI isn't where you want it.

How lenders calculate home equity

The equity in your home is the difference between your home’s current market value and what you owe on your mortgage. For example, if your home is worth $500,000 and you owe $300,000, you have $200,000 in home equity.

As you pay down a mortgage or the value of your home increases (or both), your equity generally goes up. That equity is a valuable asset you could borrow against to consolidate credit card debt, pay for repairs and renovations, or cover emergency expenses.

Most lenders won’t loan 100% of your home’s value even if you own it outright. It’s more common for lenders to limit your total debt to around 80% of the current market value. That 80% limit includes your current mortgage.

Combined loan-to-value (CLTV)

With either a home equity loan or HELOC, lenders look for applicants who will have a minimum of 15% to 20% equity left over after getting the loan. They use combined loan-to-value to determine where you'll stand with the new loan.

Let's look at an example using the numbers from above. Say you wanted to borrow $50,000. The bank would calculate your combined loan-to-value (CLTV) ratio, which adds the new loan to your existing mortgage balance. That amount is then divided by the home's value:

$300,000 + $50,000 = $350,000 

$350,000 / $500,000 = 0.7

0.625 x 100 = 70%

The bank allows a CLTV of 80%. In this case, the CLTV is 70%, well below the maximum ratio of 80%. 

How your credit history impacts a home equity loan

Lenders use your credit history to try and figure out how likely you are to repay your loan as agreed. They do this by checking your credit report with one or more of the consumer credit bureaus.

Three major credit bureaus track your credit history: Experian, Equifax, and TransUnion. They all collect similar information about your experience with credit as reported by your creditors.

Most information on your credit report goes back seven to 10 years. The most recent two years tend to have the most influence on your credit score. Your credit report will generally show:

• Your credit accounts, including accounts in good standing that were closed within the last 10 years

• The type of account (personal loans, auto loans, credit cards, etc)

• The percentage of your total credit you currently use

• The amounts of your recent payments

• Whether you’ve paid late or defaulted

• Whether you’ve applied for other new credit accounts recently

If you have overdue payments, try to catch up on those payments before applying for a home equity loan. Late payments are a red flag for any lender. 

What credit score do you need for a home equity loan?

The specific credit score required for a home equity loan or HELOC will vary by lender and loan terms. Some lenders may accept scores starting at 600, which is considered to be fair credit according to FICO. 

How you plan to use your home equity loan could affect the credit score you’ll need to qualify. If you’re going to consolidate existing debt, for instance, you may qualify with a lower score than if you're going to use the money for home renovations.

Home equity loans tend to have more flexible credit requirements than other types of loans because your home is the collateral, or security, for the loan. If you fail to repay the loan, the lender could sell your home to recoup its losses.

What goes into a home equity loan application?

Once you understand home equity and HELOC requirements, you may have a better idea of the documentation your lender is likely to request. You could streamline the application process by gathering as many of these documents as possible before applying. 

• Proof of identity. You’ll provide your Social Security number, and if you apply with a co-borrower, they’ll need to provide theirs. You may need to show a photo I.D. when you sign your loan documents.

• Proof of income. You could use recent pay stubs if you have regular employment. If you’re self-employed, you may be able to use tax returns or other documents to prove your most recent income. If you’re using Social Security, alimony, or child support to apply, you'll be asked to document that as well. 

• List of debts. The lender will want to know about any outstanding debts, who you owe money to, and how much you pay each month. 

• Appraisal and title. The bank or credit union making your home equity loan will verify property records to make sure you own your home and that you’ve included any co-owners on your application. Anyone named on the title will either need to be included on the loan or sign something saying they agree to the loan. The lender will also check your home’s current value by conducting a professional appraisal. 

Once you’re approved, the bank or credit union will write a contract for you to sign, either electronically or in person. If you’re consolidating existing debt, they may use the loan to pay off your other creditors directly. Otherwise, they’ll transfer the funds to you.

Depending on your situation, the whole process can take as long as a few weeks or as little as 10 days. Most home equity loans take an average of 15 to 18 days to fund.

What if you don’t meet the requirements?

If you don’t qualify for a home equity loan or you decide you don’t want one, you may have other options.

Personal loans

An unsecured personal loan could help you reach your financial goals. Because they aren't secured by property, you could qualify based on your credit history, not on what or how much you own.

On the other hand, unsecured personal loans are typically smaller and cost more than secured loans. The loan’s repayment time may also be shorter. 

While potentially higher than a home equity loan, the rate on a personal loan could be well below what you’re currently paying on credit card debt, so it’s worth considering if debt consolidation is your goal. A personal loan could help give you a definite timeline to pay off your bills and be debt-free.

Debt relief

If you’re overwhelmed by your debt and you know you won’t be able to pay it off, you could look into debt relief. Debt relief means negotiating with your creditors to accept less than the full amount you owe. You can do this yourself or hire a professional debt relief company to help you. For some people, debt relief makes more financial sense than bankruptcy. 

Whether your goal for a home equity loan is to consolidate debt, remodel your home, or start a small business, the ability to access the equity you've built up is one of the loan's most attractive features. If you decide a home equity loan isn't the right financial tool for you right now, it's good to know you have additional options.