Do you have an expensive home repair or remodel to complete? Or maybe it’s time to send one of the kids off to college. Whatever the reason for needing an influx of money, a home equity loan may be a good option for you to consider.
- Understand what a home equity loan is
- Discover the reasons why your home equity loan may be denied
- Learn what you can do to reduce the risk of loan denial
- Explore alternatives to a home equity loan
What is a home equity loan?
A home equity loan is a second mortgage you take out against your home’s value. It is paid off in monthly payments just like your mortgage. Because your house is used as collateral you can typically obtain lower interest rates than with other loans since the lender is able to foreclose on your house if you default.
How to qualify for a home equity loan?
Before you consider applying for a home equity loan, it is a good idea to understand the basic requirements. While not all lenders have the same standards when it comes to qualifying for a home equity loan, the following are common home equity loan requirements.
- A minimum of 15 to 20 percent equity in your home
- A minimum credit score of 621
- A maximum debt-to-income (DTI) ratio of 43 percent
- A history of on-time bill payments
- Stable employment and verifiable income history
Home equity loan denial is often out of your hands
While you might expect to be turned down for a home equity loan if you have a poor credit score or unverifiable income, the fact is, even with good credit, a bank can still turn you down. In fact, since the COVID pandemic, banks are even more likely to deny home equity loans than they were before. In some cases, banks completely halted the approval of home equity loans. As the post-pandemic economy is still uncertain, many banks are reluctant to issue home equity loans as easily as they were pre-pandemic. As the economy recovers, home equity approval will likely return to what it was before the pandemic.
Common causes for a home equity loan denial
Here we take a closer look at some of the common causes of home equity loan denial.
1. Low home equity
Your home equity is how much you have paid off toward the value of your home. It’s not necessarily how much of your loan you have paid off because your home equity is calculated using the current appraised value, not the original loan amount. To determine how much equity you have in your house, subtract the amount of your existing loan from the current appraised value. For example, if you owe 200K on your home and the appraised value is 300K, you would have 100K of home equity. To determine your percentage, take that number divided by the appraised value: 100K/300K; you have 33% home equity.
2. Credit score below 620
A low credit score alone is not always enough for a lender to deny your application for a home equity loan, but it will factor into their determination. Lenders have different minimum requirements, but generally, a score of at least 620 is required.
3. DTI is too high
DTI stands for debt-to-income ratio, and it’s the percentage of your gross monthly income that you pay toward your debts. Again, this may vary by lender, but it should come in under 43% – 50% to be considered for a loan.
4. Unstable income source
A steady income source is one of the main ways a lender determines your creditworthiness. While most don’t have a stated income level they are looking for, if you are unable to show steady income through employment, investments, or spousal support, it’s unlikely a lender will approve your application. They need to know you will be able to make regular payments and spotty income history is prohibitive.
5. Poor payment history
In addition to credit and income, lenders will also look at your payment history on rent, loans, or mortgages. They are looking for a history of on-time payments with no defaults as an indication of your ability to pay in the future.
6. History of foreclosure or bankruptcy
A bankruptcy or foreclosure remains on your credit report for at least six years. While you may have recovered from the bankruptcy and repaired your current credit score, lenders are less likely to approve a home equity loan while a bankruptcy or foreclosure still appears on your credit report.
“My home equity loan was denied, now what?”
If your home equity application is denied, don’t give up hope. There are a number of things you can do before you reapply, but you should talk with your lender about why your first application was denied. They are legally obligated to give you the information that resulted in a denial. With this knowledge, assess your personal finances and see what fixes you can make so you’ll be on better footing the next time you apply.
There are some things you can do in the short term, but other fixes will take more time before you see their effects.
There are some actions that you can take to help move your loan forward. Some short-term strategies include:
1. Large down payment
If you’re able to make a larger down payment (15% – 20%) on a home purchase, you already have that much in equity. Not only that, but you will also lower your monthly payments, and increase your DTI. This will also look more appealing to lenders as it gives them more security in case of default.
2. Provide collateral
If you’re able to, you could offer a high-value item like a vacation home, investments, or a business as collateral to help secure the loan you need. Consider this carefully, though, since this collateral becomes the lender should you default on the loan.
3. Get a co-signer
If your credit is less than stellar or you can’t show enough income to get to the right DTI, you can get someone else to co-sign on the equity loan with you. This will enable their income and credit to be used in the calculations and may boost you to where you need to be for approval.
If you aren’t on a tight timeline for a home equity loan, there are some long-term strategies that you could try. These include:
1. Boost your credit
Improving your credit score is always a worthwhile task, but it can take months for it to start improving. Make sure you are paying every debt on time and making at least the minimum payments each month. Work to pay down your balances on credit cards and put your bills on auto-pay so you know you won’t miss a payment. Over time your credit will rebound.
2. Improve your income
This is easy to say and harder to do, but if you’re able to prove more income, you will increase your DTI ratio. Position yourself for a promotion, take on a side gig such as driving for Uber or delivering with DoorDash, or search for a better-paying job.
3. Pay your existing debts
The only way for your DTI to go down is to either show more income or have less debt. If you’re unable to increase your income, the next step is to lower your debt. Start with the loans with the highest rates, as the money you’ll save on interest will be better served to go toward paying down your other debts.
Alternatives to home equity loans
Being turned down for a home equity loan doesn’t mean you are out of possible solutions. Many alternatives exist that can provide you with the money you need despite not being able to secure it through the equity in your home.
1. Personal loans
A personal loan is typically an unsecured loan from a lender that offers a fixed interest rate and fixed monthly payments. Terms for personal loans will vary based on the lender but can range from one to seven years. Because this is an unsecured loan, you do not have to worry about losing your home should you default. However, personal loan interest rates range between 5.75 percent to over 35 percent, so it is important to shop around for the best available rate.
2. 0% Intro APR Cards
If you are looking for funds to cover something like a short-term home renovation project, apply for a 0% introductory APR credit card. These promotional cards offer no interest on charges for an introductory period, often for six months to just over a year. By choosing this option, you can receive the line of credit you need and pay it off before ever having to pay additional interest.
3. Family loans
A family member that is able and willing to provide you with the needed funds is another option. In many cases, this can be a loan with little to no interest and with payment terms that can often be more flexible than with a traditional lender. Keep in mind, however, that defaulting on this loan can affect the relationship you have with your family member.
4. CD loans
If you have a certificate of deposit (CD), you can apply with your bank for a CD loan. This is a personal loan that uses your CD to secure the funds. This loan option often comes with a much lower APR as the bank is protected from default with the secured funds in the CD.
Evaluating your options after a home equity loan denial
While a home equity loan can provide the funds you need, approval is not always guaranteed, even if you have a substantial amount of equity in your home. If you are unable to secure a home equity loan despite working with multiple lenders, there are alternative options that can help you acquire the money you need.
Hero Home Programs can help
Hero Home Programs™ is committed to helping the heroes of America in their homeownership dreams. This includes assisting with home equity loans. To talk with a specialist and learn how we can help, contact us today.