Requirements for a home equity loan or HELOC in 2023

One of the biggest benefits of homeownership is the ability to build equity in your property. When you accumulate enough equity, typically by paying down your mortgage or investing in home improvement projects, you can borrow against it through a home equity loan or a home equity line of credit (HELOC).

Understanding the basics of how to get a home equity loan or a HELOC is important. Criteria can and vary by lender, but there are standard criteria that are necessary to qualify for both forms of financing. Here’s the key information on the requirements for HELOCs and home equity loans in 2023.

What are HELOCs and home equity loans?

Both HELOCs and home equity loans allow you to borrow money, using the equity you have in your home as collateral. However, the home equity loan terms and conditions are often different from those of HELOCs.

HELOC

A home equity line of credit (HELOC) is much like a giant credit card whose limit is based on the value of your home equity. During its draw period — its first several years — you can borrow funds up to a certain limit set by the lender, carry a monthly balance and make minimum payments. Any funds you repay on the principal replenish the credit line, and you can withdraw them again.

The draw period typically lasts about 10 years, during which you may only be required to make payments towards interest. Afterward, you’ll enter the repayment period, which is usually 20 years, and make monthly payments towards both the principal and interest.

The benefits of a HELOC include:

  • Flexibility: A home equity line of credit allows for flexibility during both the draw and repayment periods, enabling you to borrow only what you need up to 85 percent of your home’s value, minus outstanding mortgage payments.
  • Qualify for a low APR: HELOCs generally have lower interest rates and lower initial costs compared to credit cards.
  • Few restrictions: You are generally free to use the funds as you wish, whether you need extra cash for home improvements, debt consolidation or even travel.

Home equity loan

Similar to a HELOC, a home equity loan allows homeowners to borrow against the equity in their home. However, a home equity loan is a fixed amount of money paid out in one lump sum. Homeowners repay the loan in fixed installments over a predetermined period. Home equity loans are typically fixed-rate while HELOCs are variable-rate.

The benefits of a home equity loan include:

  • Predictable payments: Monthly payments will remain the same with a fixed interest rate.
  • Lower borrowing costs: Interest rates for a home equity loan are typically lower than interest rates for credit cards or unsecured personal loans.
  • Long terms: A home equity loan term can range from five to 30 years.
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Requirements to borrow from home equity in 2023

Home equity loans and HELOCs have their own sets of pros and cons, so consider your needs and how each option would fit your budget and lifestyle. Regardless of which type of loan you choose, home equity loan requirements and HELOC requirements are typically the same:

  • A minimum percentage of equity in your home
  • Good credit
  • Low debt-to-income (DTI) ratio
  • Sufficient income
  • Reliable payment history

1. At least 15 percent to 20 percent equity in your home

Equity is the difference between how much you owe on your mortgage and the home’s market value. Lenders use this number to calculate the loan-to-value ratio, or LTV, a factor that helps determine whether you qualify for a home equity loan.

To determine your LTV, divide your current mortgage balance by the appraised value of your home. For instance, if your loan balance is $150,000 and an appraiser values your home at $450,000, you would divide the balance by the appraisal and get 0.33, or 33 percent. This is your LTV ratio. Since your LTV ratio is 33 percent, you have 67 percent equity in your home.

This percentage determines how much you can borrow. You can usually borrow up to 85 percent of your home equity stake. That figure often applies to both your primary mortgage and the new loan together — something called the combined loan-to-value ratio (CLTV). In other words, the sum of your mortgage and your desired home equity loan can make up no more than 85 percent of your home’s value.

In the above example, 85 percent of the home’s value is $382,500. If you subtract your mortgage balance, that leaves you with $232,500 of equity to borrow with a loan.

There are a few ways to build home equity:

  • Pay your mortgage bill: Paying down your mortgage will increase the amount of equity you have in your home, and making more than the minimum payment will increase that equity even faster.
  • Make home improvements: You can also complete renovations that increase the home’s value — although keep in mind that if you wait to make home renovations using a home equity loan, you could see tax benefits.

2. A credit score in the mid-600s

A favorable credit score is essential to meet most lenders’ approval requirements. A credit score of 680 or higher will most likely qualify you for a loan as long as you also meet the equity requirements, but a credit score of at least 700 is preferred. In some cases, homeowners with credit scores of 620 to 679 may also be approved.

Some lenders also extend loans to those with scores below 620, but these lenders may require the borrower to have more equity in their home and carry less debt relative to their income. Bad-credit home equity loans and HELOCs will have high interest rates and lower loan amounts, and they may have shorter terms.

Before applying for a home equity product, take steps to improve your credit score. This could involve making timely payments on loans or credit cards, paying off as much debt as possible or avoiding new credit card applications.

3. A DTI ratio of no more than 43 percent

Your debt-to-income (DTI) ratio is yet another factor that lenders consider when reviewing a home equity loan application. The lower your DTI percentage, the better.

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Qualifying DTI ratios will vary from lender to lender. Some require that your monthly debts eat up less than 36 percent of your gross monthly income, while other lenders may be willing to go as high as 43 percent or 50 percent.

To determine your DTI, lenders will add up the total monthly payment for the house, which includes mortgage principal, interest, taxes, homeowners insurance, direct liens and homeowners association dues, along with any other outstanding debt that is a legal liability.

The debt total is divided by your gross monthly income — which includes base salary, commissions and bonuses, as well as other income sources, such as rental income and spousal support — to come up with the DTI ratio.

Before you apply for a home equity loan, calculate your DTI. If you’re above your potential lender’s optimum ratio, pay off as much debt as you can. Try starting with the debt avalanche method, where you first pay off debts with the highest interest rates. The money you save on interest can be put toward paying off other debts.

Jerry Schiano, CEO of home equity lender Spring EQ, also recommends extending the term of any outstanding loans you hold, which will reduce your monthly installment payments on the debt. However, keep in mind that extending the term of a loan could increase the amount you pay in interest during the life of the loan.

4. An adequate income

While not all lenders list specific income requirements for their home equity products, many will evaluate your income to make sure you make enough money to repay your loan. Your income level may also determine how much you are able to borrow. More critically, having a higher income or finding ways to boost that income prior to applying for a home equity loan will also improve your DTI ratio.

Be prepared to provide income verification information when you apply for your loan; examples of documents you may be asked for are W-2s and paystubs.

5. A reliable payment history

When deciding whether to issue loans, lenders want to make sure that they’re not taking on too much risk. One of the main ways to do this is to evaluate potential borrowers’ payment history.

While payment history is folded into your overall credit score, lenders may look closer to see how often you pay your bills on time. If you have a history of late payments, lenders may be less willing to lend to you, even if you have an otherwise decent credit score. This is because they don’t want to risk losing money in the event that you can’t pay your bills.

This is especially true with home equity loans and HELOCs, since these are technically second mortgages — meaning the lender will be second in line for payment should your home be foreclosed.

Should you get a home equity loan or HELOC?

Knowing how to get a HELOC or home equity loan is important, but it’s also a good idea to consider whether taking out either type of loan is a wise decision. This type of funding can be a good choice if you need money to pay for a home improvement project or consolidate high-interest debts. Since the loans are secured by your home, the interest rate is usually lower compared to unsecured loan products such as credit cards or personal loans. For example, home equity loan rates currently range between 8.01 percent to 9.91 percent, depending on the lender, loan amount and the creditworthiness of the borrower, while the average credit card rate is about 20.65 percent.

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In addition, if you use the money from a home equity loan to “buy, build or substantially improve” your home, as defined by the IRS, you may be able to deduct the interest on the loan from your taxes.

However, one major downside to consider is that if you default on the home equity loan, the lender can foreclose on your home. Before you get a loan that uses your home as collateral, make sure you have a solid repayment plan.

Alternatives to home equity loans and HELOCs

Although taking out a home equity loan can be a good financial decision, it’s not the best option for everyone.

  • Personal loans: A personal loan is a lump sum of money you receive from a lender; it comes with a fixed interest rate and fixed monthly payment. Terms usually last from one to seven years. Although most personal loans are unsecured, secured personal loans exist. A personal loan can be a better option if you can secure a lower interest rate or don’t want to risk losing your home with a home equity loan.
  • 0 percent intro APR credit cards: When you use a 0 percent intro APR credit card, you can avoid paying interest on purchases during a promotional period that often lasts between 6 and 21 months. Using this option instead of a home equity loan can help you avoid interest charges altogether if you have a short-term home renovation project.
  • CD loans: CD loans are secured by your certificate of deposit (CD) account. The lender typically charges you two to three percentage points above your current CD’s interest rate. This can be a better option if you’re looking to secure a lower interest rate than a home equity loan.
  • Family loans: Family loans are loans you get from relatives. This can be a good option if a family member is willing to let you borrow money with no or low costs. However, keep in mind that not repaying the loan might harm your relationship with your relative.

Understanding home equity loan rates

Home equity loan rates vary over time based on economic trends. In general however, many lenders tie rates to what’s known as the prime rate, which is the rate banks use as the basis to establish interest rates for all types of loans including mortgages and personal loans.

The prime rate, in turn, is influenced by the federal funds rate established by the Federal Reserve. In recent years, the Federal Reserve has been repeatedly increasing the federal funds rate in an attempt to ease inflation. Banks typically set the prime rate about 3 percentage points higher than the fed funds rate, which has caused home equity loan rates to increase over time as the Fed continues with rate increases.

Historically, home equity loan rates have paralleled mortgage rates, running a few percentage points higher.

HELOC and home equity loan FAQ

  • Can I get a home equity loan or HELOC without a job?

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  • How much equity do I need in my house to get a home equity loan or HELOC?

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  • What is the minimum credit score to qualify for a home equity loan or HELOC?

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  • Can I borrow 100% of my home equity?

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  • What happens if I default on my home equity loan or HELOC?

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Additional reporting by Mia Taylor