How To Qualify For A HELOC In 4 Steps

A HELOC, or Home Equity Line of Credit, is a revolving line of credit based on the equity you have in your home. It can be a fantastic tool to leverage your home’s equity, giving you the funds you need at a good interest rate. But you may be wondering—what are the qualifications for a HELOC? The requirements for most lenders are similar, but may vary a bit. Plus, how much you qualify to borrow will depend on a few factors.

In this article, you will discover HELOC qualifications, which documents to prepare, and how to determine if a HELOC is the right option for you.

Steps to Qualify and HELOC Requirements

Step 1: Estimate your home’s equity and learn how much you can borrow

In order to qualify for a HELOC, you will often need a minimum of 15% to 20% equity in your home. To calculate an estimate of your home’s equity, divide what you owe on your mortgage from your home’s estimated current value.

For example, let us say you purchased your home for $350,000. You do some research and understand its current market value to be approximately $425,000. After a review of your outstanding debt on the home (such as a second mortgage or even another home equity loan), you still owe $275,000. Your equity is calculated by taking the value, minus the debt ($425,000 - $275,000 = $150,000).

There are limits to how much you can borrow, no matter how much equity you have. That limit will be based on your loan-to-value ratio (LTV). You can calculate this by dividing your mortgage balance by your home’s current value. Lenders also look at all of your debt on the property against its value—this is called the combined loan-to-value ratio (CLTV). In most cases, your lender will want the CLTV to be no higher than 85% to qualify. You can calculate your CLTV by adding up all of the secured loans on your property (first mortgage, any home equity loans, and so on) then divide that number by the value of your home.

Continuing with our example above, a lender may look at your home value of $425,000 and use an 80% LTV ($425,000 x .8 = $340,000). The next step in determining how much you can borrow is to subtract what you still owe on the home ($275,000) to determine what you may qualify for ($425,000 X .8 = $340,000.00 - $275,000 = $65,000).

For PenFed, the minimum loan amount is $25,000. The max HELOC amount is $500,000.

Step 2: Check your credit score and payment history

To qualify for a HELOC, many lenders may require a minimum credit score of 680.

As with most other loan options, your lender will thoroughly review your credit score and payment history. Although, a score of 700 or higher is even better and can help you get a better rate.

Since a HELOC is technically a second mortgage, your lender will also want to be sure you will reliably pay back what you owe. Your overall payment history is a big contributing factor to your credit score, and lenders will pay close attention to it.

Step 3: Prepare income documentation

To qualify for a HELOC, applicants must provide their recent W-2, pay stubs, or tax returns.

You have to show evidence you can afford repayment by providing documentation to your lender showing you have enough income to qualify for a HELOC. Income and accompanying documentation includes:

• Employee wages: Most recent W-2 and pay stubs.

• Self-employment: Most recent federal tax returns.

• Social security benefits: Benefit verification letter.

• Other benefits or income: Retirement award letters, benefit statements, or 1099 forms.

Step 4: Check your debt-to-income ratio (DTI)

To qualify for your HELOC, typically you will need a DTI ratio no higher than 43% to 50%.

Your debt-to-income ratio (DTI) is a key determinant to whether you qualify for a HELOC. DTI is the amount you owe on monthly debt payments (such as a mortgage, credit cards, car payments, and so on) compared to your monthly income. Lenders consider your DTI to determine if you can reasonably manage taking on more debt.

HELOCs can be risky, especially if you have a higher amount of debt already. If this is the case, it may be better to look into other loan options or start by paying down the debt you currently owe.

How to apply for a HELOC

If you are looking to apply for a HELOC, it is easy to go online and complete an application. By going through the process, you will get an idea of how much you may need to borrow. One of the advantages of a home equity line of credit is that it is easier and faster than a traditional mortgage.