How to Qualify for Home Equity Loans

Make the equity in your home work for you.

Make the equity in your home work for you.

The amount of money you can borrow when applying for a home equity loan is based on several factors including your home's loan-to-value. Personal finance columnist Liz Pulliam Weston points out that in most markets, lenders allow you to borrow up to 85 percent of the equity in your home, which is calculated by subtracting the amount you still owe on the first mortgage from the appraised value of the home. Your credit rating, length of employment and ability to repay the loan are other things a lender consider before making a loan.

Build up equity in your home. Equity is the difference between the appraised value of the home and the amount of money you owe on your mortgage loan. You may be able to increase the value of your home by making minor changes and repairs.

Pay down your mortgage loan so that there is a larger gap between the amount you still owe and the current market value of your home. Many lenders take a percentage, usually about 75 percent of a home’s appraised value, and deduct the balance owed on the mortgage from that amount. This helps them arrive at a loan amount for which a borrower qualifies.

Establish good credit. You need to have a positive credit history to qualify for a home equity loan. Avoid having delinquent accounts, over the limit credit lines, a bankruptcy or other serious credit problems. If you’ve had credit problems in the past, work on improving your credit score before you apply for a home equity loan.

Pay down some of your other outstanding debts before you apply for a home equity loan. You want to be able to show potential lenders a lower debt to income ratio. Pay extra on small debts for a few months so that you can pay them off sooner. Don't open any new credit accounts in the months preceding your plans to obtain a home equity loan.

Maintain a consistent employment history. Lenders like to see that a loan applicant has a verifiable income and has been working for the same employer or in the same profession for a reasonable length of time -- typically at least two years. Generally, lenders ask to see W-2 forms for the past two years. Likewise, if you are self-employed or earn more than 25 percent of your income from commissions, a lender will ask to see your tax returns for the last two years.

Demonstrate your ability to repay a home equity loan. Earning a sufficient income is only one step toward showing that you can repay the loan. Cut down on unnecessary expenses so that the lender can see that you have more of your earnings left over each month. According to Bankrate, lenders usually prefer it when borrowers keep their debt-to-income ratio below 36 percent. In other words, a lender wants to see how much of your current monthly income goes toward paying your regular bills.

Warning

  • If you are worried that you may not be able to afford to repay a home equity loan, but the lender doesn’t seem to be concerned, be careful. You could become the victim of a home equity loan scam. Promises of guaranteed loan approval with no credit check is usually a sure tip off.

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