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, student 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
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.
What is a good debt-to-income ratio for a home equity loan? ›
A debt-to-income ratio of around 43% or less
Typically, lenders require a DTI of 43% or lower.
What disqualifies you from getting a home equity loan? ›
High debt levels
In addition to your credit score, lenders evaluate your debt-to-income (DTI) ratio when applying for a home equity loan. If you already have a lot of outstanding debt compared to your income level, taking on a new monthly home equity loan payment may be too much based on the lender's criteria.
How difficult is it to qualify for a home equity loan? ›
Home equity loans are relatively easy to get as long as you meet some basic lending requirements. Those requirements usually include: 80% or lower loan-to-value (LTV) ratio: Your LTV compares your loan amount to the value of your home. For example, if you have a $160,000 loan on a $200,000 home, your LTV is 80%.
How much income do I need for a HELOC? ›
While there's no universal minimum HELOC income requirement, lenders will consider your personal cash flow along with other factors to evaluate your ability to repay any debt you incur on the credit line. Income and employment verification for HELOC applicants typically involves submitting pay stubs or tax returns.
Are home equity loans based on income? ›
There isn't a set income requirement for a HELOC or home equity loan, but you do need to earn enough to meet the DTI ratio requirement for the amount of money you're hoping to tap. You'll also need to prove that you have income consistently coming in.
What is the monthly payment on a $50,000 HELOC? ›
Assuming a borrower who has spent up to their HELOC credit limit, the monthly payment on a $50,000 HELOC at today's rates would be about $375 for an interest-only payment, or $450 for a principle-and-interest payment.
Do home equity loans ever get denied? ›
While a home equity loan can provide the funds you need, approval is not always guaranteed, even if you have a substantial amount of equity in your home.
When not to use a home equity loan? ›
Don't: Use it to Pay for Vacations, Basic Expenses, or Luxury Items. You have worked hard to create the equity you have in your home. Avoid using it on anything that doesn't help improve your financial position in the long run.
What is a disadvantage of a home equity loan? ›
Home Equity Loan Disadvantages
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Most lenders are going to require an appraisal to get a home equity loan. There are several reasons for this that we'll get into below, but at a high level, it comes down to risk management. If you default on the loan, your lender has to try to make back their investment in a sale.
What are the minimum requirements for a home equity loan? ›
Most lenders prefer you to have at least 15% to 20% equity in your home before considering a home equity loan. Your home's market value should be 15% to 20% higher than your outstanding mortgage balance.
Why is no one offering home equity loans? ›
Homeowners in the market for a home-equity line of credit, which is a revolving line of credit secured by a mortgage, might find them difficult to come by these days. Several large banks suspended the origination of these loans last year because of the pandemic and resulting economic uncertainty.
What debt-to-income ratio is too high for HELOC? ›
Lenders will want you to have a debt-to-income ratio of 43% to 50% at most, although some will require this to be even lower. To find your debt-to-income ratio, add up all your monthly debt payments and other financial obligations, including your mortgage, loans and leases, as well as any child support or alimony.
What is the DTI for a home equity loan? ›
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%.
Can you get a HELOC without proof of income? ›
It's possible to get a no-income verification HELOC without a full-time job as long as you have some form of cash flow. Not having a job isn't the same as not having an income. Many homeowners manage to pay off their mortgage loans consistently without steady employment.
What is considered a healthy 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 is too high of a debt-to-equity ratio? ›
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 12% a good debt-to-income ratio? ›
It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
