For some homeowners, working remotely has led to an increased recognition of things that could be done to make their homes more attractive and valuable. One of the best ways to get the money you need for renovations is by applying for a home equity line of credit.
At Addition Financial, we work with homeowners everyday to help them understand HELOC requirements.One of the most common questions we hear is:
“What is home equity and what are the requirements for a HELOC?”
Before you apply, it’s essential to understand what equity is, how much you have and what you need to qualify for a home equity line of credit. Here are six HELOC requirements you need to know.
What is Home Equity?
Let’s start by defining home equity since it’s a term that causes some confusion. Your home equity is your interest in your home, meaning that it’s the percentage of your home that you own outright. Unless you have paid off your mortgage, you probably share ownership of your home with the lender who gave you your mortgage.
To calculate your home equity, you will need your home’s fair market value and the amount of any outstanding liens (mortgages, loan, tax liens, etc.). Subtract your total liens from the value of your home to determine how much equity you have.
For example, let’s say you have a home that’s worth $350,000 today. Your mortgage balance is $250,000 and you have no other outstanding liens on your home. That means you have $100,000 of equity. You may express equity as a percentage. In this case, you have equity of 28.57% in your home.
Requirements for a Home Equity Line of Credit
A home equity line of credit or HELOC uses your equity in your home as collateral. A HELOC differs from a home improvement loan in that it is a revolving line of credit. If you had a $100,000 line of credit with a draw period (the time when you’re allowed to borrow against the HELOC) of 20 years, you could borrow far more than your credit limit over time. You pay only for what you borrow and as you repay, more money becomes available for you to use.
As you might expect, HELOCs have some requirements. If you want to qualify, here are six things you’ll need.
#1: Home Equity
Let’s start with the most obvious requirement. To get a HELOC, you need equity in your home. You’re probably wondering how much equity you need.
A good rule of thumb is that you need 20% equity to qualify for a HELOC. For example, if you had a home worth $200,000, you would need $40,000 in equity to qualify for a HELOC. Homeowners who make a sizeable down payment on a home start out with a good amount of equity.
Addition Financial has some specific rules regarding home equity and HELOCs. You will need:
- 20% equity if you want Addition Financial to have a second lien behind another lender.
- 10% equity if you want Addition Financial to have a second lien behind a first mortgage with Addition Financial.
- 100% equity for a manufactured home, meaning that Addition Financial will only provide a HELOC if we are in the first lien position.
Keep in mind that if you are close to the amount of equity you need, you have the option in most cases to make extra mortgage payments toward your principal to get to where you need to be.
#2: A Primary Home or Vacation Home
A HELOC is an affordable way to pay for improvements to your property but the option of a HELOC is there only for certain properties. You may qualify for a HELOC if you have:
- A first home/primary residence where you live alone or with your family, or
- A second home or vacation home that you use for residential purposes.
HELOCs are not available for investment or commercial properties. If you own an apartment building, an office building or a residential home that you rent out year-round, you cannot qualify for a HELOC. You may be able to get a commercial real estate loan to pay for renovations.
#3: An Acceptable Debt-to-Income Ratio
One of the most important determining factors in whether you will qualify for a HELOC is your debt-to-income ratio. When you take on a HELOC, you will be taking on an additional debt obligation each month that can vary based on how much you borrow. Calculating your DTI helps lenders determine whether you can afford the payments for the HELOC.
To calculate your DTI, you will need to add your monthly debt obligations together. These payments must include:
- Mortgage payments
- Car payments
- Insurance premiums
- Credit card payments
- Tax payments
Total everything and then divide the total by your gross monthly income. Your gross income is the amount you earn before taxes. Someone who earned $60,000 a year would have a gross monthly income of $5,000. If that person had $2,000 per month in debt obligations, their DTI would be 40%.
#4: A Good Credit History and Score
You’ve probably guessed that your credit history and score play an important role in your HELOC application. While there may be exceptions, it’s a good rule of thumb that you will need a minimum credit score of 620 to qualify for a HELOC.
To put that in perspective, most lenders consider a score between 580 and 670 to be “fair.” The elements that affect your credit score include:
- Your payment history
- The number of accounts you have
- The length of your credit history
- The types of accounts you have
- The amount of credit you’re using versus the amount of credit you have available
Your payment history accounts for approximately 35% of your score. If you want to improve your score, making on-time payments is the quickest way to do it.
#5: An Accurate Home Appraisal
How much is your home worth on the current market? Knowing the answer to that question is essential if you want to qualify for a HELOC.
Home appraisals are based on tangible things such as the size and location of your home and its condition. They also take market conditions into consideration. If properties in your neighborhood are selling at high prices, then your home appraisal will be higher than it would be if the reverse were true.
Remember, the amount you can borrow will be calculated by taking your home’s appraised value, subtracting your liens and multiplying it by the percentage you can borrow. If you have a HELOC that allows you to borrow up to 80% of your equity and you had $100,000 in equity, the borrowing limit of your HELOC would be $80,000.
#6: Supporting Documentation
Finally, you will need to complete your lender’s HELOC application and provide supporting documentation for the application. You will need to have the following documents when you apply for a home equity line of credit:
- Pay stubs for the most recent 30 days for all applicants
- W-2s for the previous two years
- Proof of homeowner’s insurance
- Asset statements
- Proof of additional income (if you are self-employed, earn money from rental properties or from bonuses or commissions, you will need your most recent 2 tax returns.)
Let’s talk about asset statements since that may be a term you’re not familiar with. An asset statement is a list of any assets you own that could be converted to cash if the need arose. You should include:
- Checking accounts
- Savings accounts
- Certificates of Deposit
- Investment and retirement accounts
- Money market accounts
The list of your assets shows lenders that you have money beyond what you bring home in your paycheck each month. You don’t need to have huge assets to qualify but even a small retirement account or investment account can work in your favor when you are applying for a HELOC.
How Do HELOCs Work?
HELOCs are different from traditional loans because you have a revolving line of credit. Instead of getting a one-time cash payout of your loan, you will be able to borrow against your line of credit at the timing you choose. If you withdrew the full amount of your HELOC, you would need to repay some of the balance to have additional funds available.
Addition Financial’s HELOCs typically have a 20-year borrowing term with an additional 15 years for repayments. That means your total term would be 35 years. However, you always have the option of repaying what you owe and not borrowing additional funds. You pay only for what you borrow.
If you want the cash to remodel or renovate your home with flexible borrowing and terms, a HELOC may be the solution you need. You’ll be able to plan your renovation and buy supplies and pay contractors on a schedule that works for you.
Are you considering remodeling your home? Click here to learn more about Addition Financial’s home equity lines of credit or to begin the online application process.
Posted on Oct 6, 2020
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