What Do Lenders Look For in Home Equity Applications?
If you're facing financial strain in your life, a home equity loan might be the answer to your credit issues. Not only does settling your high-interest debt with a low rate home equity loan cut down on your liability, but it diversifies your credit mix and can improve your credit score to boot.
While you may face higher interest rates and lower loan limits with a damaged credit profile, it doesn't necessarily preclude you from obtaining financing. In most cases, home equity loans and HELOCs will still prove to be significantly cheaper than alternative sources of financing and many lenders are willing to be flexible for a borrower with a lot of equity in their home.
All hope is not lost if your credit has taken a hit, you'll need to be aware of the following criteria however.
Debt to Income Ratio
Your debt-to-income ratio is based on the amount you owe vs how much you earn and is an indication of your ability to repay your debts. Most lenders will look for a ratio of no more than 40%, although certain lenders have some flexibility around that figure.
Loan to Value Ratio
Your loan-to-value ratio measures the amount currently owed on your home versus its current appraised value. Lenders will factor in the amount you wish to borrow for this calculation. Most lenders will get nervous if your loan-to-value ratio goes above 80%, but many are willing to lend up to as much as 90%. Certain qualifying military borrowers may even be able to borrow up to the entire value of their homes.
The elephant in the room, your credit score will affect your rate, terms, and odds of approval. Minimum scores usually start at 620, but lenders will be in the lookout for things like bankruptcies, shortsales, and foreclosures.
How Can You Improve Your Application if Your Credit Isn't Great?
You should start by minimizing your debt-to-income ratio, either by paying down or consolidiating your existing debts.
Minimize Your LTV
It goes without saying that most lenders will be willing to approve smaller loan amounts (with certain minimum limits). Ask about each lender's threshold for the loan you're looking for, and do your best to stay within those bounds. You can also shop around for home equity lenders with high-permitted LTV ratios, if squeezing as much equity out of your home is an absolute necessity.
Fix Errors on Your Credit Report
While this is an important step here, it's good financial practice to check over your credit report annually to make sure there are no errors. A red mark on your credit report through no fault of your own can cause headaches down the line when you attempt to apply for credit, Just as important, you should avoid taking on any new credit applications while you search for a home equity loan.
Add a Co-Signer
If your debt-to-income ratio sits just parallel to the lender's maximum threshold, you may want to consider adding a close family member as a co-signer to bolster your application. That way, the lender will take your combined income and debts will be taken into account which may enable you to borrow greater amounts. Keep in mind that the lender will review your co-signer's credit profile in TANDEM with yours; in no way can their credit profile serve as a substitute, which may make this a non-starter if your co-signer also doesn't have particularly good credit.
Finally, one of your best options is to shop around for a lender who will approve you if one or two won't. Instead of trying multiple banks, expand your search out to credit unions and online mortgage lenders as well. Certain entities are subject to a different set of regulations than others, so it may pay to look at different type of lenders to find the one who's willing to work with you.
Find Another Option
If all else fails, you may need to find another option, such as a cash-out refinance or personal loan. If you can't get a home equity loan because you've hit your maximum loan-to-value cap, a cash-out refinance may still allow you to rework your initial mortgage while eeking out a small payout at closing. If you have an outstanding VA or FHA loan, you may be able to find a more lenient qualification process through a VA or FHA streamline/cash-out refinance.