Home equity loans allow you to leverage the equity you have in your home and turn an illiquid asset — your property — into more readily-available cash. In other words, you borrow against the percentage of the home you own.
While a home equity loan can help you access the equity you do have, the loan is still debt — meaning it costs money for you to leverage and it’s something you need to repay. You receive a lump sum of money from a lender and you need to make monthly payments, with interest, to pay the loan back by a certain time (set by your loan terms).
For this reason, people sometimes use a home equity loan to add more value to their house through a renovation or improvement. Other reasons for taking a home equity loan include paying for higher education, starting a business, or paying off high interest debt. Does that sound like something that makes sense for your financial situation? Here’s what you need to know about qualifying — including the credit score you need for a home equity loan.
How to Qualify for the Home Equity Loan You Want
The most important requirement for a home equity loan is that you have, well… equity. You need to have at least 20 percent equity in your home for a lender to consider you for a loan against that value — and keep in mind they won’t allow you to borrow against all the equity you have.
You might need an appraisal to confirm the value of your home (and therefore, exactly how much equity you have in the property). Keep in mind that you’ll pay for the appraisal, which adds to the overall cost of the loan.
You’ll need to show that you have sufficient income to repay your loan once you get it, too. Lenders want to know you can reasonably repay what you borrowed. In addition to income, lenders also consider your credit score to determine how risky of a borrower you may be.
The Credit Score You Need for a Home Equity Loan
Your credit score is one of the variables that helps a lender determine what interest rate they’re willing to offer you, and the maximum amount of financing they’ll provide. A higher credit score will usually allow you to obtain a lower interest rate and more financing.
The better your score, the more likely you are to qualify, get a good interest rate, and borrow the full amount you request.
“Generally, lenders look for a credit score of 700 or higher,” says Van Papadopoulos, a senior mortgage banker at Goldwater Bank. “Some lenders will go down to 680 or even 660, but the overall credit profile and financial picture in those situations have to be very strong.”
Papadopoulos explains that lenders will consider more than just your credit score and don’t look at that number in a vacuum.
“If there was a reason for a run-up in credit usage that led to the drop in credit score — like going through divorce, experiencing an illness, or starting a new business, — that might be a compensating factor for a lowered credit score,” he explains.
In addition to your credit score, you need to be aware of your past payment history. “ Past late payments on mortgages can sometimes be a disqualifying factor for a home equity loan,” says Papadopoulos.
Before you head to a lender, check up on your credit to see where you stand. If you find that your score is well below 700, you might want to take action to improve your credit score before seeking a home equity loan.
Need to Improve Your Credit Score? Here’s Where to Start
The simplest place to start when it comes to improving your credit score is to ensure you make all your payments on time and in full. Late and missed payments make a bigger impact on your score than almost any other factor.
Set reminders in your calendar, autopay bills — do whatever you need to make sure payments you owe get in on time.
Then, keep your credit utilization ratio in check. This represents the amount of credit you use out of the total amount of credit you have available to you. If you have a credit limit of $1,000, for example, and carried a balance of $500, your credit utilization ratio would be 50%.
Aim to keep that number to 30% or less — even if you pay off those balances each month.
You can also work to repay any existing debts you may have. If you have a credit card balance or lingering student loans, you may want to focus on paying them off entirely before applying for a home equity loan.
“Home equity lenders prefer borrowers to have a relatively low debt ratio, which is the percentage of your monthly income that goes toward servicing debt,” Papadopoulos explains. “This is because home equity loans take a riskier lending position than first-lien lenders do.”
Finally, don’t forget to request a copy of your credit report at AnnualCreditReport.com. You can get a free copy once every 12 months; if you request it more than that, you’ll need to pay $12.95 each time you receive your report.
Check your report for errors. Incorrect information can hurt your credit score, so you want to get any mistakes removed from your report as quickly as possible by disputing the errors.
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