A Step-by-Step Guide to Unlocking Your Home's Equity

A home equity line of credit offers a flexible, affordable borrowing solution. If you have equity in your home, you can apply for a HELOC. If you are approved, you'll be given a line of credit you can draw from as needed. These loans work like credit cards, but with a lower interest rate.

This guide will explain what's required to get approved for a home equity line of credit and how to go through the application process.

1. Make Sure You Qualify for a HELOC

The first step is to make sure you meet the requirements for a HELOC. While these can vary slightly by lender, here's what you typically need to qualify:

• A fair or good credit score: Lenders have different minimum credit requirements. Typically, you would need a score of at least 680 to 720.
• Proof of income: Lenders like to see stable employment (often at least a year or two) and proof that you have enough income to pay the debt. Typically, lenders don't want your debt-to-income ratio (the ratio of what you owe to what you earn) to be too high. This can vary from around 36% to 43%, depending on the lender, while a small number of lenders may go as high as 50%.
• Equity in the home: Lenders usually cap total home equity borrowing at around 80% of the market value of your home. This means all the loans you have on your house, including your primary mortgage and your HELOC, can't add up to more than 80% of your home's fair market value. You'll likely need to get an appraisal to determine its value.

How Much Equity Do You Need?

Since eligibility for a home equity line of credit requires having equity, it's important to understand how much home equity you need.

This can vary by lender. However, the total combined value of all of your mortgage and equity loans usually can't exceed around 80% to 85% of the value of the house. This means, for example, that if your home's value is $500,000, the most you'd be able to borrow across all mortgage and equity loans is around $400,000 to $425,000.

Remember, though, that your current mortgage is part of that calculation. If you have a $400,000 mortgage, you might be able to borrow $25,000 if your lender caps the loan at 85%, or nothing at 80%.

You also want to be cautious about taking too much equity out of your house or owing more than your home is worth. This makes selling or refinancing difficult or impossible.

Credit Score and Financial Requirements

Your credit score serves as a quick and simple way for lenders to determine if you've been responsible with borrowing. Credit bureaus collect information from lenders on things like payment history, amount of debt used, and length of credit to assign your score. The specific score you need for a HELOC varies by lender, but if your score is below around 680, it will be difficult to find HELOC options.

You'll also need proof that you have enough income to pay the loan. As mentioned above, most lenders want to see your total debt payments below around 36% of your monthly income, but some will go as high as 43% or even 50%.

2. Gather Documentation for Your HELOC Application

Preparing your documents in advance will help the application process go more smoothly, so gather the following before you apply:

• Identification: You will usually need a primary ID, such as a driver's license, passport, or other state-issued photo ID, to prove your identity. You may also need proof of your current address, such as a recent utility bill.
• Income verification: You should be ready to provide pay stubs, bank statements, or other documentation showing your income and where it comes from.
• Proof of employment: Lenders want to confirm that you're currently employed. They may need a letter from your company or your employer's contact details to verify your position.
• Tax returns: Tax returns from the prior two years can provide helpful financial details to lenders, including confirming income and expenses. Tax returns are especially important if you're self-employed.
• Bank statements: Finally, some lenders want to see that you have assets available to cover costs if needed.

3. Submit Your HELOC Application

When you have your documents in place, you're ready to apply.

Depending on the lender, you may be able to submit an application online, via phone or email, or in person. You'll need to provide your financial details and details on your home, so completing the application process can take anywhere from a few minutes to upwards of an hour.

Lenders may provide conditional approval, dependent on the home appraisal and underwriters verifying all information. Getting conditional approval can take anywhere from a few days to a few weeks, with most lenders falling somewhere in the middle on the timeline.

4. Home Appraisal and Underwriting

Once you have preliminary approval, your home will be appraised by a professional to determine its fair market value. The home appraisal is necessary so the lender can make sure you have enough equity to borrow.

An underwriter will also do a careful review of your file to verify all of the information you provided and evaluate the risk the lender is taking on by giving you a loan. The underwriter must approve the HELOC before the process can move forward.

5. Close on Your HELOC

When you're finally approved, you'll close on your HELOC. It can take several weeks to get from application to closing. At closing, you will need to sign paperwork, so make sure to bring your ID to prove your identity.

You have a three-day right to rescission after closing, which means you can change your mind and cancel the loan with no penalty. Your funds won't be distributed until after the three days have passed.

6. Access and Repay Your HELOC Funds

After final approval, you don't automatically get a lump sum payment like you would with a home equity loan or a mortgage. Instead, you can access your funds when you need them, typically by requesting a deposit into your bank account, asking for a check, or using a debit card. Your payments will also start right away once you borrow, but you'll only owe based on the amount of credit you've used, and you initially only need to make interest payments. Most HELOCs have variable rates, so the interest you pay will change over time.

Draw Period vs. Repayment Period

HELOCs typically have two separate periods. During the draw period, you borrow as needed and make interest-only payments based on your current balance. Once your loan enters the repayment period, you must start working on repaying principal and interest, and you can no longer access your credit line.

Final Thoughts: Ready to Apply for a HELOC?

A HELOC is a flexible and affordable way to borrow against the equity in your home, provided you have the income and credit to qualify and are comfortable with a variable-rate loan.

If you think this type of loan is right for you, contact Freedom Mortgage to get started on a HELOC application today.