A home equity loan is a second mortgage that allows you to borrow against your equity. You receive a lump sum of money that you can use for whatever you’d like. These loans usually come with a fixed interest rate for predictable monthly payments and have term options of five to 30 years.
Let’s look at how much equity you need to qualify for a home equity loan, how to calculate your own home equity, and how you can increase your home’s equity.
- Many lenders require a minimum 20% equity to qualify for a home equity loan.
- Lenders use your current principal balance and home value to calculate your loan-to-value (LTV) ratio.
- To boost your equity, you can make extra payments, wait for your home’s value to rise, or make home improvements.
- You can usually borrow up to 80% or 85% of your home’s equity.
Minimum Equity Requirements for Home Equity Loans
Your home equity represents your ownership interest in the home. It’s the home’s appraised value minus the principal balance remaining on the current mortgage. Therefore, if your home is worth $500,000 and your principal balance is $300,000, your home’s equity would be $200,000. The percentage of equity would be the equity amount ($200,000) divided by the home’s worth ($500,000), which is 40%.
Many home equity loans are for people with 20% or more equity in their homes. However, lender requirements vary, so you might qualify with less than 20% equity. Your lender will assess your loan-to-value (LTV) ratio—which is your remaining mortgage balance divided by your home’s appraised value—to determine your equity. For example, an LTV of 80% would mean that you have 20% equity in your home.
Other factors can affect the minimum equity requirement. Lenders often don’t allow you to borrow the full amount of equity, and might limit you to 80% or 85% of it. In addition, lenders can set minimum and maximum home equity loan amounts. These rules can result in higher minimum equity requirements for you to qualify or get a sufficient loan amount.
How to Calculate Your Loan-to-Value Ratio
Your lender will do an official LTV ratio calculation during the home equity loan application process, but you can gather some information to assess your potential eligibility beforehand.
Find Your Current Principal Balance
Get your most recent mortgage statement and look for the line mentioning the principal balance. This is often shown in the account information section. If you don’t have a statement available, check your lender’s portal to locate the outstanding principal. You could also call the lender and have them check. If your home already has multiple mortgages, you’ll need to add each principal balance together.
If you’ve made any payments since the last statement, your home equity has likely changed as the principal went down. You can still use the old number to get a rough estimate, but your lender can provide the most up-to-date information.
Determine Your Home’s Current Appraised Value
The most accurate way to find your home’s appraised value is by getting a professional appraisal done. Your lender will likely require you to arrange one during the application process, but you could also have an appraisal performed beforehand. The appraiser will evaluate your home’s condition and consider the market to get an accurate value.
For a rough estimate of your home’s value, you can look at the sale prices of similar homes nearby, use the Federal Housing Finance Agency House Price Calculator, or consult property tax records. If you bought your home relatively recently, you could use the sales price as a baseline, but keep in mind the value may have changed.
Perform the LTV Ratio Calculation
Next, divide your principal balance by your property’s appraised value to calculate your LTV ratio. If your principal balance is $300,000 and your appraised value is $400,000, the calculation would be:
$300,000 / $400,000 = 0.75 = 75%
Since the loan amount is 75% of this property’s value, you have 25% equity in your home. This exceeds the typical minimum equity requirements, so you’d more likely qualify for a home equity loan.
How to Increase Equity in Your Home
If you fall short of the minimum home equity requirements, or if you don’t have enough equity for the loan amount you want, you have ways to build equity. The best options will depend on how quickly you need to build equity and how much money you can contribute.
Pay More Toward the Principal
If you have the funds, you can build equity by contributing extra money toward your mortgage principal. You’ll need to verify, however, that your specific lender allows extra principal payments. You must also specify this intent when you make the payment.
Extra principal payments also help reduce the overall interest paid over your mortgage term.
If you’re short of the equity requirements and you need the funds sooner, you could pay a large lump sum toward the principal for faster results. For example, you might use a large work bonus, tax refund, or even a gift from a family member. You could also consider a side job for extra income to put toward your mortgage.
Consider Home Improvements to Add Value
Both internal and external home characteristics affect the market value, so you can consider upgrades to increase home equity. For example, you might remodel your kitchen, get new siding, or add a room. Keep in mind certain home improvements, like those done for accessibility or after a disaster, may not raise the value.
You can recoup some of the costs of home renovations and upgrades if you sell the property later. However, you’ll need to have enough cash or borrow funds for home improvement projects.
Wait for Appreciation From Market Changes
The national average for home appreciation is 3% annually, but many factors can affect your property value. They include market demand, the location of your home, and its condition. Since home prices generally appreciate, you could simply wait to get a home equity loan if you don’t need the loan immediately.
How Do You Get a Home Equity Loan With Bad Credit?
A good credit score of at least 700 is ideal for getting a home equity loan. However, lenders may consider you with a score in the mid-600s. If you have a lower credit score, you might get approved with a higher interest rate or lower home equity loan amount. You can consider compensating with a lower debt-to-income ratio or a higher amount of home equity to be more appealing to lenders. In addition, consider steps to reduce debt and improve your credit score.
How Much Can You Borrow With a Home Equity Loan?
Typically, lenders limit your home equity loan amount to 80% or 85% of your equity. However, some will allow you to borrow 100% of the equity. In addition, any lender-specific minimum and maximum loan amounts apply.
Your allowed loan amount ultimately depends on your lender’s rules as well as factors such as your property value, credit score, and debt-to-income ratio. The lender will consider the combined loan-to-value (CLTV) of your existing mortgage plus the home equity loan to assess affordability.
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