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The two most common ways to access the equity you’ve built up in your home are to take out a home equity loan or a home equity line of credit. Loans offer a lump sum at a fixed interest rate that’s repaid over a set period of time. A HELOC is a revolving line of credit that you can draw on, pay back and draw on again for a set period of time, usually a decade. It often starts with an adjustable-interest rate followed by a fixed-rate period.
A third option is a cash-out refinance, where you refinance your existing mortgage into a loan for more than you owe and pocket the difference in cash.
Requirements for borrowing against home equity vary by lender, but these standards are typical:
Equity in your home of at least 15% to 20% of its value, which is determined by an appraisal
Debt-to-income ratio of 43%, or possibly up to 50%
Credit score of 620 or higher
Strong history of paying bills on time
To consider your application for home equity borrowing, lenders calculate your debt-to-income ratio to see if you can afford to borrow more than your existing obligations.
To find this number, add all monthly debt payments and other financial obligations, including mortgage, loans and leases and child support or alimony, then divide by your monthly income and convert that number to a percentage. For example, your DTI is 40% if you earn $3,000 a month and make payments totaling $1,200.
What debt-to-income ratio do lenders require? For a fixed-rate, fixed-term home equity loan, federal regulations set the limit at 43% DTI.
With HELOCs, lenders have more discretion, meaning that you can shop around if your DTI is higher. Comerica makes home-equity lines of credit with DTIs up to 50%, says Winston McEwen, assistant banking center manager at Comerica Bank in Cupertino, California. Chase sets a 43% debt-to-income limit for HELOCs, according to its website.
This range of standards requires consumers to use their best judgment. Even if you do qualify, think carefully about how much debt to take on. When you borrow on your home’s equity, you’re putting your house on the line as collateral, which means the bank could take the house if you don’t make the loan payments on time.
Lending strategies vary, “so what one lender may consider a ‘good score’ another may consider nonprime,” says Ethan Dornhelm, vice president of score and analytics at FICO. At Comerica, for example, the minimum FICO score for home-equity borrowing is 680, McEwen says.
Depending on your lender, borrowers with prime FICO scores (from 740 to 799) and super-prime scores (800 and up) may drive a better bargain. But not always. While some lenders use formulas relying heavily on credit scores, others emphasize the big picture. Standard Bank, in Monroeville, Pennsylvania, looks at several factors, says CEO Timothy K. Zimmerman.
“If you have an 820 credit score and I have a 680, that doesn’t mean you are going to get a better rate. You might have an 820 score, but you might have a lot of credit outstanding,” Zimmerman says.
Generally, you can borrow up to 80%, and sometimes 85%, of the property’s value, minus its mortgaged debt, says Ron Haynie, senior vice president of mortgage finance policy, at Independent Community Bankers of America, a trade group of banks serving local communities.
Standard Bank’s Zimmerman says customers with exceptionally low DTIs can, on a case-by-case basis, sometimes borrow up to 89%.
In short, debt-to-income ratio is key. If your mortgage balance is $200,000 and your home is worth $325,000, your credit limit would be $60,000 if you borrow 80%.
Here’s the math:
$325,000 x 80% = $260,000. Then $260,000 – $200,000 = $60,000 credit limit
To find your home’s value, you’ll need an appraisal, which costs about $300 to $500.
A less popular option for accessing home equity is to refinance into a new mortgage, then extract some of your equity in cash. Your interest rate in a refinance depends on your current mortgage interest rate. Zimmerman says the borrowers he works with are shying away from this kind of refinancing because they would end up with a higher interest rate than what they are paying now.
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