What are the requirements for a HELOC?

Learn about qualifying for a home equity line of credit

When you have equity in your home, you can use it to get cash to pay for things like college or home improvements. You can also use the cash to consolidate high-interest debts.

One way to get cash from your home equity is with a home equity line of credit (also called a "HELOC"). Home equity lines of credit work much like credit cards do. You can choose how much money to take out from a HELOC, up to a certain limit. You can choose when you take the money out during a set period of time when you can access available funds (this is called the "draw period").

You also make monthly payments on HELOCs. Often, you are only required to make interest payments during an initial period. After the draw period, you'll make monthly principal and interest payments until the HELOC has been paid off. Other ways to borrow against your home equity include home equity loans and cash out refinances.

To qualify for a HELOC, you need to meet the requirements set by the lender. Lenders typically look at your home equity, your loan-to-value ratio, your debt-to-income ratio, and your credit score before they decide whether or not you qualify for a home equity line of credit. These numbers can also affect the interest rate they might offer you on a HELOC. Let's look at these requirements in more detail.

Variable interest rate requirements for HELOCs

Many HELOCs require you to accept a variable interest rate. This means the amount of your interest payments may change over the life of the loan. Your interest payments might go up, down, or stay the same.

Other home equity loans, such as cash out refinances, often have fixed rates. This means that the amount of your interest payments will stay the same over the life of the loan. Many homeowners like the peace of mind that comes with knowing their interest payments won’t change.

Credit score requirements for HELOCs

Different lenders have different credit score requirements for HELOCs. The credit reporting agency Experian says borrowers typically need a credit score of 680 to qualify for a home equity line of credit.

At Freedom Mortgage, we can often help you qualify for a cash out refinance with a lower credit score than may be required for a HELOC. Our typical minimum credit scores depend on the loan type.

• We can often accept a minimum credit score of 620 for a Conventional cash out refinance.
• We can often accept a minimum credit score of 550 for a VA loan cash out refinance.
• We can often accept a minimum credit score of 550 for an FHA loan cash out refinance.

Home equity and loan-to-value ratio requirements for HELOCs

To qualify for a HELOC, the first requirement is having enough home equity. Your home equity is the current market value of your house, minus what you owe on your mortgage and any other loans and/or liens against it. For example, if your house is currently worth $250,000, and you owe $125,000 on the mortgage, then you have $125,000 in home equity.

However, most lenders will not allow you to borrow the full amount of your home equity with a HELOC. Instead, they will set a limit to the amount of money you can borrow, based on a loan-to-value ratio (or "LTV"). You can calculate your loan-to-value ratio by dividing the amount of your mortgage and other loans against your house by the value of the house, then transforming the result into a percentage.

Using the example above, if your house is worth $250,000, and you owe $125,000 on the mortgage, then your loan-to-value ratio is 50%. (That is $125,000 ÷ $250,000 = 0.50 or 50%.) Some lenders who offer HELOCs have a maximum loan-to-value ratio of 80%. They might use this maximum amount to decide how much you may be able to borrow, like this:

In this scenario, you might be able to get a home equity line of credit of up to $50,000. That's because the amount of the HELOC, plus the amount you owe on your mortgage, can be no higher than $200,000. Generally speaking, it is easier to qualify for a HELOC when you have a large amount of home equity and a low loan-to-value ratio.

Debt-to-income ratio requirements for HELOCs

Another number many lenders consider before they decide you qualify for a HELOC is your debt-to-income ratio (or "DTI"). Your debt-to-income ratio is the total of all your monthly debt payments, divided by your gross monthly income.

For example, imagine your total monthly debt payments for a mortgage, plus your car loan, equals $1,500, and your gross monthly income is $5,000. This means that your mortgage debt-to-income ratio is 30%. ($1,500 ÷ $5,000 = 0.30 or 30%.)

When lenders are deciding whether or not you qualify for a HELOC, they will take your current total monthly debt payments, add them to an estimate of what your payments for the new HELOC might be, and then calculate a new, higher debt-to-income ratio. Lenders usually have a maximum DTI for you to qualify for a HELOC. Your debt-to-income ratio must stay under this maximum.

The maximum DTI varies for different lenders. Some lenders follow the guidelines of the Consumer Financial Protection Bureau, which recommends that people keep their debt-to-income ratio under 43%. Other lenders might accept a higher DTI. Overall, the lower your debt-to-income ratio, the easier it can be to qualify for a HELOC.

Last reviewed and updated September 2023 by Freedom Mortgage.