What are the requirements for a HELOC? – Forbes Advisor
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A home equity line of credit (HELOC) can be a good option if you’re looking to tap into the equity in your home, for example, to pay for home renovations or consolidate debt. As with other loans, there are common requirements to qualify for a HELOC, such as having a good credit rating and sufficient equity in your home.
If you’re wondering how to get approved for a HELOC, here’s what you need to know.
How does a HELOC work?
A HELOC is a type of revolving line of credit that you can withdraw and repay repeatedly, like a credit card. Although guidelines may vary, you can typically access around 80% of your home’s equity with a HELOC. Repayment terms can be up to 30 years, depending on the lender.
Keep in mind that unlike a credit card, the duration of a HELOC is divided into a drawdown and redemption period. During the drawdown period, which typically ranges from five to 15 years, you can make withdrawals from your HELOC up to your credit limit and are only required to make minimal interest payments.
Thereafter, you will not be able to make any more withdrawals and will have to repay any amount borrowed during your repayment period, which usually ranges from 10 to 20 years.
Although the eligibility criteria for a HELOC may vary by lender, there are some common requirements.
Have some equity in your home
Equity is the amount you have left after dividing what you owe on your mortgage from the current value of your home. To qualify for a HELOC, you must have at least 15% to 20% equity in your home.
Keep in mind, however, that there are limits to how much you can borrow with a HELOC, regardless of how much capital you have. The limit offered to you will be based on your loan-to-value (LTV) ratio, which you can calculate by dividing your mortgage balance by the current value of your home.
Lenders will also look at all of your debt on the property against its value, called the combined loan-to-value ratio (CLTV). Most lenders want your CLTV no higher than 85% to qualify for a HELOC, although some lenders will tolerate CLTVs as high as 90%. To calculate your CLTV, add up all the loans secured on your property (like your first mortgage, any home equity loans, etc.), then divide by the value of your home.
Have good credit
Lenders look at your credit score and history to determine if you are a risky investment. To be approved for a HELOC, your credit score must be between 600 and 600, although a score of 700 or higher is even better.
Having good credit can also qualify you for a better interest rate. In general, the higher your credit score, the lower your rate.
Show sufficient income and documentation
Lenders want to see that you can afford to repay, so you must show that you have enough income to qualify for a HELOC. You will need to provide documents that show your employment and income information. The income and accompanying documents could include:
- Employee salaries: W-2 and most recent payslips
- Self-employment : Latest federal tax returns
- Social security benefits: Letter of verification of benefits from your Social security account
- Other benefits or income: Pension award letters, benefit statements, or 1099 forms
Show a solid payment history
Another way for the lender to determine how good a borrower you are is by reviewing your payment history. Although your payment history is a major factor in your credit score, the lender might pay special attention to it over the other components of your credit score.
Because a HELOC is technically a second mortgage, the lender will want to be especially sure that you will reliably repay what you owe.
Have a low amount of debt
Your debt-to-income ratio (DTI) is the amount you owe on monthly debt payments (like your mortgage, credit cards, etc.) relative to your monthly income. Considering your DTI ratio helps lenders determine if you can reasonably handle taking on more debt. This ratio is essential in determining if you qualify for a loan.
To qualify for a HELOC, you will generally need a DTI ratio no higher than 43% to 50%, although some lenders may require ratios lower than this.
How to apply for HELOC
If you’re ready to apply for a HELOC, follow these five steps:
- Compare lenders. Be sure to shop around and compare your options with as many lenders as possible to find the right HELOC for your needs. Consider not only interest rates, but also repayment terms, fees charged by the lender, and eligibility requirements.
- Gather your documentation and complete the application. After choosing a lender, you will need to complete a full application. Many lenders offer an online application option, while some traditional banks and credit unions may require a visit to your local branch. Be ready to provide the required documents, such as bank statements, W2 forms or payslips.
- Have your house appraised. If your income and credit are approved, the lender will usually request an appraisal to calculate the current value of your home. In most cases, the lender will schedule the home appraisal, but be prepared to pay the appraisal fee, usually $300 to $400 for a single family home.
- Prepare for closing. After your home is appraised, your lender will let you know if you’ve been fully approved for a HELOC and provide additional details, such as your credit limit and interest rate. If you decide to continue, you will need to sign your loan documents. Keep in mind that all closing costs will be added to your loan amount.
- Access your funds. After the loan closes, you will have three business days to withdraw from the loan if you change your mind. After that, you will have access to your HELOC and can start making withdrawals at your leisure.
How long does it take to get a HELOC?
It usually takes about two to four weeks to complete the process of applying for and closing a HELOC. In some cases, it can take up to six weeks, depending on the lender and the complexity of your application.
Alternatives to a HELOC
If a HELOC isn’t right for you, there are a few alternatives to consider.
However, since this type of loan is riskier for the lender, you could end up with a higher interest rate compared to what you would get with a HELOC.
Refinancing by collection
With a cash-out refinance, you’ll pay off your first mortgage with a second loan for more than you owe. You’ll then get the difference as a lump sum to use as you wish, minus any closing costs or fees.
Unlike a HELOC, a cash refinance won’t earn you an extra monthly payment because you’re simply replacing your mortgage with another loan. However, you still risk losing your home if you cannot meet your payments.
Home Equity Loan
You can also consider tapping into your home’s equity in another way with a home equity loan. Unlike a HELOC which gives you access to a revolving line of credit, a home equity loan is paid out in a lump sum, similar to a personal loan.
Home equity loans usually come with fixed interest rates, which means your rate and payment will stay the same for the life of your loan. Since this type of loan is secured by your home and poses less risk to the lender, you will likely get a lower interest rate than you would be offered on a personal loan. However, keep in mind that this also means the bank could foreclose on your home if you don’t make your payments.
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