The best way to navigate the world of home finance is to understand the tools and options available to you as you choose from various loan types, terms, and requirements. Among this list of options, one of the most flexible and useful is the home equity line of credit (HELOC). So, what is a HELOC, and who qualifies for one?
In this article, we’ll explore the HELOC eligibility rules and requirements.
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What Are HELOCs?
A home equity line of credit, or HELOC, is a type of revolving credit secured by the equity in your home. Unlike a traditional mortgage or a home equity loan, where you receive a lump sum borrowed against the value of your home, a HELOC can be thought of as similar to a credit card. With a HELOC, homeowners can borrow money as they need, up to a pre-approved limit. When you pay off the money you’ve used, you can borrow it again.
The flexibility of a HELOC makes it a popular choice. With a HELOC, you can cover large expenses that might not have defined costs, such as home renovations that require a flexible budget. You can also use a HELOC to do things like consolidate high-interest debt or manage large unexpected expenses.
Interest rates on HELOCs are typically variable, meaning they fluctuate throughout the life of the loan depending on market conditions. Borrowers only pay interest on the money they’ve withdrawn, not the entire credit line.
A HELOC will usually have two phases: the draw period, when you can borrow against the line of credit, and the repayment period, when you must pay back whatever funds you’ve borrowed, plus interest. However, you can often pay back funds before the repayment period; though, this may vary from lending institution to lending institution.
What Are the Most Common HELOC Eligibility Requirements?
Home Equity
At the core of the idea of a HELOC is the main requirement: you must have sufficient equity in your home. Equity is the difference between the market value of your home and the amount you owe on any liens. Most lending institutions require that you have at least 15 or 20 percent equity in your home to qualify for a HELOC. For instance, if your home is valued at $300,000, you should owe less than $240,000 on your original mortgage to be sure you meet the threshold.
Credit Score
Your credit score is another key factor that determines HELOC eligibility. Your credit score is a numerical representation of your creditworthiness, based on your lending history and other financial behaviors. The minimum credit score for HELOC approval varies by lender.
Lower credit scores may still get approval for a HELOC but will usually come with higher interest rates as a tradeoff. Conversely, better credit scores will not only increase your chances of approval but also help you secure better interest rates.
Loan-to-Value (LTV) Ratio
The loan-to-value ratio, or LTV ratio, is a measure of the relationship between the loan amount and the value of your home. For a HELOC, lenders usually require an LTV ratio of 80 percent or lower, meaning the total debt secured by your home—including the HELOC—should not exceed 80 percent of its market value.
Some lenders may offer HELOCs to borrowers with higher LTV ratios, but as with your credit score, these will often come with higher interest rates or extra fees.
Debt-to-Income (DTI) Ratio
The debt-to-income ratio, or DTI ratio, is another critical factor governing HELOC eligibility. This ratio measures what portion of your monthly income goes toward paying your debt. Lenders will use this ratio to evaluate your expected ability to manage monthly payments and repay borrowed money. If you already owe too much money every month, they might doubt your ability to repay your HELOC. A DTI ratio of 36 percent or lower is usually preferred, but this, again, can vary.
What Will Your Lender Use to Evaluate Your HELOC Application?
In addition to the above criteria, HELOC eligibility will be determined by the lending institution evaluating some or all the following factors. Some individual lenders may have additional or specific requirements for approving or rejecting your HELOC application:
Proof of Employment and Income
A lending institution wants to ensure that you’re making money. Lenders will usually require proof of stable income and employment to ensure you can repay borrowed funds. Proof can include recent pay stubs or tax returns.
Home Appraisal
A professional appraisal may be required to determine the current market value of your home. This helps lenders calculate the available equity in your home as well as the amount they are willing to extend in the HELOC.
Outstanding Debts
This is partially covered in your DTI ratio, which we discussed above. However, the type of debt can matter too. A lower-interest debt, such as a student loan, may be treated differently than if you had lots of high-interest debt on things like credit cards. Lenders don’t want your new HELOC to overextend your finances.
History of Bankruptcy
A history of bankruptcy or foreclosure can significantly impact your HELOC eligibility. Depending on how recent it is, this could be reflected in your credit score. If you have ever declared bankruptcy or foreclosed on a home, lenders will typically require a certain period of time to have passed since these events to demonstrate increased reliability in repaying debts.
HELOC Eligibility: Are You Eligible?
Securing a HELOC requires you to carefully consider your financial situation in addition to understanding the various HELOC eligibility requirements lenders might set. Key first steps are to assess your home equity, credit score, and LTV and DTI ratios and ensure your income is sufficient so that you can take on any new debt without breaking the bank, so to speak.
If you’re considering a HELOC, you should research and compare different lenders’ terms and requirements. Talk to a financial expert, like Mid-Hudson Valley Federal Credit Union, to see if a HELOC will align with your goals. Remember, while a HELOC is a potent financial tool, it represents a significant commitment because your home serves as collateral.
By understanding the HELOC eligibility requirements and preparing accordingly, you’ll be able to navigate the HELOC process more effectively in order to make informed decisions for your financial health.
