A home equity loan -- more commonly referred to as a second mortgage -- allows you to borrow money against the equity in your home. Several factors -- including the loan-to-value ratio -- determine whether you are eligible for a home equity loan. The situation is not much different than when you applied for the first mortgage. Lenders still want reassurance you are capable of paying back your loan, which means they will review your credit score, history and income.
Credit score requirements vary by lender and loan type -- conventional, VA or FHA. Chase, for example, as of 2012 required a credit score of 700 to take out a home equity loan, but Refinance Tool Box states that scores can be as low as 680. Even with a high credit score, however, your application can still rejected if your history is inadequate and your income is insufficient.
A good credit history will show no bankruptcy, repossession, foreclosure, delinquency or other outstanding negative credit entry -- that is, one reflecting an account that is currently not being properly maintained. Some lenders might require two years of clean credit history following the resolution of a negative entry.
Employment and Income
During the application for a primary mortgage, your debt-to-income ratio is assessed to see how much of a payment you can afford. For a home equity loan, your lender reviews your debt-to-income ratio again. You must again provide proof of income with Form W-2 or Form 1099, along with income tax returns for two years and statements regarding assets and other investment income you want the lender to consider. The lender will total your current expenses -- including monthly, recurring debts such as auto loans, student loans and credit card payments, as well as your current mortgage payment and your projected payment on the home equity loan. Your monthly gross income is divided by your monthly debt obligations to determine your DTI ratio. According to Refinance Tool Box and Chase, the preferred DTI for home equity loans is 45 percent or below.
A good credit score and low DTI are not enough to qualify for a home equity loan: Your home’s unpaid principal balance and the appraised value of your home also come into play. Lenders typically determine your loan amount based on a ratio between the unpaid principal of the primary loan and the appraised value of your home. Assume, for example, that your home has an appraised value of $100,000 and your lender allows 80 percent of the appraised value for a loan. If you still owe $50,000, your lender will subtract that from $80,000 -- 80 percent of $100,000 -- and the remaining $30,000 is what you will receive. The average LTV ceiling is 80 percent, but some lenders may have stricter requirements.
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