Borrowing money can seem like a math test at times since lenders use equations to know if they will approve you for a loan. For example, what is the maximum loan to value (LTV) for a home equity line of credit or HELOC? There’s a solution to equations like this, and this guide has the answers.
What is the Loan-to-value (LTV) Ratio in a HELOC?
The loan-to-value (LTV) value is a number that compares your home loan amount and the market value of your home to help lenders determine if they can take the risk on you with a line of credit. Lenders need to understand how much equity you have in the home before they can offer you a HELOC or home equity loan. Equity is the term used to describe the difference between your current mortgage balance and the appraised value of your home. Since LTV is a very common number that will play a role in your application for a HELOC, it’s one reason an appraisal is required when you are applying for a HELOC or home equity loan.
Reasons Why the LTV is Important When Getting a HELOC
There are a few reasons why lenders will consider your LTV when you apply for a HELOC. For example, banks and credit unions won’t loan you more money on your home in the form of a HELOC if your LTV ratio is greater than 100%. That would mean you owe more than the home is worth, which is commonly called being underwater on your home loan. Your LTV can affect the interest rate you pay on a HELOC as well. If your LTV is high, lenders will charge a higher interest rate on the HELOC, so it benefits you to understand your LTV and manage it if possible.
How to Calculate Your Loan-to-value Ratio
If you’re wondering how to calculate your loan-to-value ratio, divide your current loan balance by your home’s appraised value. You can find the current balance on your monthly mortgage statement. Once you have divided the balance by the appraised value, multiply that number by 100 to convert it to a percentage. For example, if your current loan balance is $250,000 and your home is appraised at $350,000, your LTV is 71%. As you repay your mortgage and the amount you owe decreases, the LTV will decrease as well. But if property values drop and home prices fall, your LTV could increase.
What is the Maximum LTV You Can Have in a HELOC?
The maximum LTV you can have in a HELOC varies based on many factors, including the lender you are working with, your credit score, your current income, the value of your home, the housing market in your community and more. If you’re getting a home equity line of credit, the amount of the home’s equity is key. Lenders will usually offer a HELOC if you qualify based on the factors they require and your LTV is up to 85%, meaning you have equity in your home of 15%.
Common Requirements to Get a HELOC
In order to qualify, there are some common requirements to get a HELOC. However, your eligibility for a HELOC is based on many factors, some of which are out of your control.
Home Equity
With home values booming nationwide, it may be easy to meet the home equity requirement to get a HELOC or home equity loan. Simply put, your home must be worth more than you owe on the mortgage to qualify for a HELOC. In addition, there must be equity available for you to borrow against. Most lenders will approve you for a line of credit if you have about 15% to 20% home equity built up. The amount of equity you have in your home will help the lender determine the maximum size of the line of credit you are eligible to borrow. Every time you make an on-time mortgage payment, you are building equity in your home by reducing the size of the debt. Also, if you make home improvements that enhance the value, the home equity will increase. Be mindful that home values fluctuate, so if you use a HELOC and values drop, you could end up owing more on your home than it is worth.
Credit Score
Most lenders will require a good credit score in order to approve your HELOC application. On the usual scale of 300 to 850, your credit score must be well above 600 and even closer to 700 to get a HELOC or home equity loan from most banks, credit unions or other financial institutions. Some lenders, however, are more flexible when it comes to your credit score if your home’s equity is sufficient and you meet other qualifications as determined by the lender. In that case, you can expect to pay a higher fixed rate and be approved to borrow less in your line of credit. In addition, lenders will usually pull your credit report and review it to see about your history with student loans, car loans, credit cards and any other type of debt you may have. Any past and current mortgage activity will be included in your credit report as well.
Debt-to-income Ratio (DTI)
Your debt-to-income ratio, or DTI, will be considered before you are approved for a HELOC. Some lenders won’t approve a line of credit unless your monthly debts are less than 36% of your monthly income. Other lenders may be more willing to approve a HELOC even if your DTI is up to 50%. There is a simple equation for calculating your debt-to-income ratio. First, add up all your monthly payments, including your first mortgage, credit card minimums, car payment, student loans, second mortgage and others that are due regularly. Then, divide that total by your gross monthly income. That’s your paycheck before deductions, as well as other income sources, such as child support, part-time jobs or side gigs. Here is the debt-to-income ratio equation:
DTI ratio = Total monthly debt payments / total monthly income
Before you apply for a HELOC, it’s a good idea to take steps to reduce your DTI by paying down debts. You may even be able to increase your income if you have time and capacity. These steps will help you improve your financial situation and be in a better position to make monthly payments on the HELOC and save money for future needs.
Income
In order to get a HELOC and access cash from your mortgage, you will need to meet the lender’s income requirements. It’s a requirement since your income plays a vital role in your ability to pay debts. The income requirement varies depending on the bank or credit union, but don’t expect them to list a specific income you need to earn. Lenders will request copies of your paystubs or income tax documents to verify your income during the HELOC application process, so it’s a good idea to gather that information beforehand.
Payment History
Your payment history will be an important qualification if you want to get a HELOC. Have you paid your mortgage on time every month? Have you ever had a penalty or late fee for missing a due date? Your lender will review your payment history carefully and decide if you are worth the risk in approving a HELOC. In addition to looking at your first mortgage payment history, they may also consider whether you have a solid payment history on your credit cards, second mortgage and other debts. That information will be available in your credit report, which lenders will most certainly study.
