Is a Home Equity Loan Difficult With a High Debt Ratio?

A home equity loan is a second mortgage on a residence.
i Thinkstock/Comstock/Getty Images

With a home equity loan, you use the built-up equity in your home as collateral for the loan. In order to qualify for this type of mortgage, the lender will look at your overall financial picture, including your other debt payments, to determine if you can afford the new debt. Typically, if a borrower's debt ratio is higher than the lender's set standards, he will not be approved for the new mortgage debt.

Debt-to-Income Ratio

The first ratio that most lenders look at when making a decision on new financing is the debt-to-income ratio, or DTI. This the total sum of all your monthly debt payments divided by your total pre-tax income. Most lenders want this number to be less than 40 percent; some even have requirements that are lower than that. The higher the DTI, the less likely you are to receive new financing.

Ways to Lower DTI

One way to lower the DTI is to lower the new loan amount. The DTI is calculated with the projected new loan payment in the mix. Asking for less money might reduce your DTI enough to qualify for the home equity loan. Additionally, paying off your other debts, such as car loans or credit card balances, can lower the DTI.

Credit Report

The information used for a DTI calculation comes from the borrower's pay stubs, income taxes and credit report. Be sure that all reported income is included -- if you're not reporting all your income, your DTI will appear to be higher than it really is. Additionally, review your credit report to ensure that all the information is correct. Any incorrect information will be used in your lender's calculations: for example, if you've paid off your car loan in full but the credit report doesn't reflect this, your DTI will appear inaccurately high.

Adding a Second or Third Borrower

The lender looks at the DTI of all borrowers in the transaction. If a second or third borrower with a very low DTI is added to the transaction, it could bring the DTI down to an acceptable range for the lender. Keep in mind, however, that the new borrower will be liable for the debt, just as you are. If you were to default on the loan, this would negatively affect the other borrower's credit score.

the nest

×