Home Equity Qualifications

Daniel Hale By Daniel Hale masslive.com
on September 27, 2017 at 8:52 AM, updated September 27, 2017 at 8:55 AM
To qualify for home equity loans, you need to have a high credit score.

For a long time now, homeowners have tapped into their home equity in order to make home improvements, pay down credit card debt, or to pay for college tuition for their children. A home equity loan also referred to as a second mortgage, is a type of loan that is extended by a mortgage lender based on how much equity you have acquired on your property. You can be able to access a certain amount of money based on how much you have paid towards your mortgage.


A home equity loan is a popular option because it often comes with lower interest rates than other loans. In addition, the interest rate is normally fixed, giving borrowers stability and peace of mind when taking out the loan. Most home equity loans in Alabama and nationwide are currently going for 5.5%.

While it sounds like an appealing option, qualifying for a home equity loan is often more difficult than it sounds. Lenders tend to put guidelines in place to secure themselves against the risk of having to repossess a home in the event of default.

How Much Can You Borrow?

To find out how much home equity you can access, consider the current value of your home as well as how much you currently owe on your mortgage. Subtract your total mortgage balance from the value of your home to get how much you can access. Some lenders require you to maintain a10% to 20% equity in your home when you borrow (this is often referred to as the loan to value ratio, LTV), which can reduce the accessible amount. Most lenders in Alabama require equity of 20% (or LTV of 80%). 

If, for example, you have a home that is worth $350,000 and your current mortgage balance is $180,000, you would be able to access up to $170,000 ($350,000- $180,000). If the lender requires you to retain 20% equity (or have an LTV of 80%), you would be able to access a maximum of $136,000.

Income Requirements

In the same way as your first mortgage, you need to show that you're able to keep up with the new monthly payments for your home equity loan. You must be able to show a solid work history and an earnings record over a period of at least 2 years. The lender will consider your income and how much debt you currently have in order to determine eligibility.

For business owners or those who are self-employed, you need to show proof of income through the relevant tax documents. W-2s and 1099T forms from the past two years may be required by the lender as proof of income.

Cash Reserves

Lenders may also require you to have cash reserves that can cover a few months of mortgage payments. The cash reserves requirement ranges between 2-6 months, depending on your credit score and your debt to income ratio.

All these items normally play off each other. A high credit score often allows you to maintain a higher debt to income ratio and lower cash reserves without significantly affecting your eligibility. On the other hand, a lower credit score often needs to be compensated by a lower debt to income ratio and higher cash reserves.

Credit Score

To qualify for home equity loans, you need to have a high credit score (often 660 and above in Alabama). Higher scores lead to better interest rates and eligibility for larger loan amounts. Homeowners with a credit score of 740 and above can qualify for the best loans. For scores between 660 and 740, the lender may consider additional factors such as your debt to income ratio and the loan to value ratio.

Your debt-to-income ratio is a comparison between how much you owe and how much you earn on a monthly basis. A low debt-to-income ratio (for example you owe much less than you earn) can enable you to access more of your home equity. Most lenders require a ratio of about 36%, but some lenders can go as high as 45% based on your individual circumstances.

The Loan is Issued as a Lump-Sum

In most cases, you are required to take out the home equity loan as one lump sum payment. You will then repay a fixed amount each month until the loan is cleared.

Home equity loans are therefore a great option for homeowners looking to clear a debt or other payment at once, knowing that they have the security of a fixed interest rate during repayment.