You may need to tap your home equity for any number of reasons, such as for cash for a big remodeling project, a second home, or a child's education. Having home equity means you could be eligible for a relatively low interest rate home equity loan.
But simply having equity isn't enough to qualify for these loans. Lenders look for borrowers who have other criteria that make them lower risk, such a low debt-to-income (DTI) ratio. Here is what you need to know about how your DTI ratio plays a role in whether you qualify for a home equity loan.
Key Takeaways
- When you apply for a home equity loan, lenders will look at your debt-to-income (DTI) ratio as one measure of your ability to repay.
- Your debt-to-income ratio compares all of your regular monthly loan and credit card payments to your gross monthly income.
- Many lenders will want to see a DTI of less than 43%.
What Is a Home Equity Loan?
A home equity loan is secured by the equity in your primary residence. Your equity is the difference between your home's current market value and how much you owe on it. With every mortgage payment you make, you build some equity in your home. Home improvements or a rising housing market can also increase your equity.
Once you have at least 20% equity in your home, many lenders will consider you for a home equity loan. If you're approved, you'll typically get payment in the form of a lump sum that you will then repay over an agreed-upon period of anywhere from five to 30 years.
Home equity interest rates, typically slightly above primary mortgage rates, are often an attractive alternative to high-interest personal loans or credit cards. The downside is that if you can't make your loan payments, you risk losing your home.
If you have a DTI higher than 43%, lenders may not qualify you for a home equity loan. Consider applying for a home equity line of credit (HELOC) instead. This adjustable-rate home equity product tends to have more flexible requirements for borrowers.
What Is a Debt-to-Income Ratio (DTI)?
Your debt-to-income ratio (DTI) indicates the percentage of your monthly income that is committed to paying off debt. That includes debts such as credit cards, auto loans, mortgages, home equity loans, and home equity lines of credit. If you make child support payments or pay alimony, those can also count toward your DTI.
To calculate your DTI, divide your total monthly debt payments by your total gross income. For example, if your monthly debt payments total $3,000 and your gross monthly income is $6,000, your DTI is 50%
What DTI Do You Need for a Home Equity Loan?
More than anything, lenders want borrowers who can pay back their loans regularly and on time. To that end, they look for people with low DTIs because it indicates that they has sufficient income to pay for a new loan after paying their current debt obligations.
The maximum DTI that most home equity loan lenders will accept is 43%. Of course, lower DTIs are more attractive to lender because it indicates you have more room in your budget to afford a new loan. A lower DTI can make you eligible for a larger loan or a lower interest rate, or both.
To decrease your DTI, you can pay off some debts before applying for a home equity loan. Paying down your credit cards is one way to do that. Reducing your credit card balance will also lower your credit utilization ratio, which can boost your credit score, further helping you qualify for a loan.
The Consumer Financial Protection Bureau (CFPB) suggests that homeowners aim for a total DTI no higher than 36%. In terms of mortgage debt alone it suggests a DTI of no more than 28% to 35%.
Can a Good Credit Score Make up for a High DTI?
Typically, no, but this could vary by lender. However, it's possible that a very low DTI might persuade a lender to take a chance on you if you have an unattractive credit score. Each lender will have its own ways of quantifying your creditworthiness. So, if you're turned down by one lender, another one might still offer you a loan.
Can You Have More Than One Home Equity Product at a Time?
Yes. As long as you have enough equity to borrow against and you meet the qualifications for each product, you can have multiple home equity loans, or a home equity loan and a HELOC. To account for all your loans, prospective lenders will look at your combined loan-to-value (CLTV) ratio to determine how much more you can borrow.
Can You Pay Off a Home Equity Loan Early?
Yes, you usually can. Most home equity loans don't have early payoff penalties, but you should check with your lender before signing your closing papers. If there is a penalty and you want to pay your loan off early, calculate whether that strategy would still save you in interest with a penalty.
The Bottom Line
When you're thinking about getting a home equity loan, you'll also want to consider the impact that another loan payment will have on your monthly budget. Your DTI is one metric that lenders use to predict how capable you will be to pay them back.
If you use nearly half of your income goes to paying debt, another loan payment may strain your budget. And if you can't keep up with your mortgage or home equity loan payments—due to a job loss or other financial emergency—you could lose your home. So aim for a lower DTI, for both your qualifying creditworthiness and your own peace of mind.
FAQs
When you apply for a home equity loan, lenders will look at your debt-to-income (DTI) ratio as one measure of your ability to repay. Your debt-to-income ratio compares all of your regular monthly loan and credit card payments to your gross monthly income. Many lenders will want to see a DTI of less than 43%.
What is a good debt-to-income ratio for a home equity loan? ›
Qualifying DTI ratios can vary from lender to lender, but, in general, the lower your DTI, the better. Most home equity lenders look for a DTI ratio of no more than 43 percent. Lowering your DTI ratio can help improve your odds of qualifying for a home equity loan or HELOC.
How hard is it to get approved for a home equity loan? ›
You generally need at least a 620 credit score to qualify. However, the best rates and terms are often reserved for those with higher credit scores. If your credit score is keeping you from qualifying for a home equity loan, it can be helpful to take steps to improve it.
Is home equity loan based on income? ›
Typically, conventional home equity loans require borrowers to have a stable source of income to qualify. However, some home equity loans and equity loan alternatives will forego income requirements and evaluate based on other qualifications. A lender may consider other factors, such as: Credit score and credit history.
What credit score is needed for a home equity loan? ›
In many cases, lenders will set a minimum 620 credit score to qualify you for a home equity loan — though the limit can be as high as 660 or 680 in some cases. Still, there are some options for a home equity loan with bad credit.
What is the monthly payment on a $50,000 HELOC? ›
Average 30-year home equity monthly payments
| Loan amount | Monthly payment |
|---|
| $25,000 | $166.16 |
| $50,000 | $332.32 |
| $100,000 | $673.72 |
| $150,000 | $996.95 |
What disqualifies you for a HELOC? You may be disqualified from opening a HELOC if you do not meet the lender requirements. This may include low equity in your home, inadequate income or a low credit score.
What is the payment on a $20,000 home equity loan? ›
Now let's calculate the monthly payments on a 15-year fixed-rate home equity loan for $20,000 at 8.89%, which was the average rate for 15-year home equity loans as of October 16, 2023. Using the formula above, the monthly principal and interest payments for this loan option would be $201.55.
What is the monthly payment on a $100,000 home equity loan? ›
If you took out a 10-year, $100,000 home equity loan at a rate of 8.75%, you could expect to pay just over $1,253 per month for the next decade. Most home equity loans come with fixed rates, so your rate and payment would remain steady for the entire term of your loan.
Why does a home equity loan get denied? ›
Lenders want to make sure that you can pay back the loan, so they'll lend only to those who can prove sufficient income. If you don't have traditional employment or a stable source of income, you may have trouble qualifying for a home equity loan or HELOC.
Do all home equity loans require an appraisal? Yes. Lenders require an appraisal for home equity loans—no matter the type—to protect themselves from the risk of default. If a borrower can't make monthly payments over the long-term, the lender wants to know it can recoup the cost of the loan.
How long does it take to get approved for a home equity loan? ›
Getting a home equity loan can take anywhere from two weeks to two months, depending on your preparation of documents (such as W2s and 1099 tax forms and proof of income), your financial situation, and state laws. The home equity loan process time varies from lender-to-lender.
What is an acceptable debt-to-income ratio? ›
35% or less: Looking Good - Relative to your income, your debt is at a manageable level. You most likely have money left over for saving or spending after you've paid your bills. Lenders generally view a lower DTI as favorable.
Is there a minimum amount for home equity loan? ›
Every lender sets its own terms for home equity loans, but most set a minimum amount of about $35,000 on the size of the loan. About $10,000 is the absolute minimum available.
Does having a home equity loan hurt your credit? ›
When you take out a loan, such as a home equity loan, it shows up as a new credit account on your credit report. New credit affects 10% of your FICO credit score, and a new loan can cause your score to decrease. 4 However, your score can recover over time as the loan ages.
Does everyone get approved for a home equity loan? ›
Homeowners typically need a combined loan-to-value, or CLTV, of at least 80% to qualify for a home equity loan. This means a maximum of 80% of your home is financed, and you have at least 20% equity in the home to borrow from. Having strong credit and a low debt-to-income ratio can also help you get approved.
What is a really good debt-to-equity ratio? ›
What is a good debt-to-equity ratio? Although it varies from industry to industry, a debt-to-equity ratio of around 2 or 2.5 is generally considered good. This ratio tells us that for every dollar invested in the company, about 66 cents come from debt, while the other 33 cents come from the company's equity.
What debt-to-equity ratio is too high? ›
Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky. If a debt-to-equity ratio is negative, it means that the company has more liabilities than assets—this company would be considered extremely risky.
Is a 7% debt-to-income ratio good? ›
DTI is one factor that can help lenders decide whether you can repay the money you have borrowed or take on more debt. A good debt-to-income ratio is below 43%, and many lenders prefer 36% or below. Learn more about how debt-to-income ratio is calculated and how you can improve yours.
Is 4.5 a good debt-to-equity ratio? ›
The maximum acceptable debt-to-equity ratio for more companies is between 1.5-2 or less.
