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Combined Loan-to-Value (CLTV) Ratio
The most critical HELOC requirement is an assessment of the combined loan-to-value (CLTV) ratio on your property that an underwriter will perform. CLTV is calculated by dividing the sum of the remaining balance owed on your mortgage and all the other loans tied to your property by the appraised value.
Mortgage balance = the current balance of your mortgage on the home
Total HELOC line = if you already have a HELOC in its draw period, this is the total amount you could pull from your HELOC. If your HELOC is in its repayment period, this is the current balance of your HELOC.
Home equity loan balance = the current balance of your home equity loan or second mortgage on the property
Other balances with liens on property = examples of other balances with liens on the property might include tax liens from the IRS or mechanic’s liens for contractors who have provided labor and supplies to the property
It's important to remember that when calculating your CLTV during the draw period for a HELOC, lenders will use the entire credit line available to you with your HELOC, so even the unused part of your HELOC balance will count toward CLTV calculations. However, once you are out of the draw period, only the remaining balance will count toward your CLTV.
Additionally, most lenders are unwilling to take a third-position lien on your property. So if you have an existing HELOC or home equity loan, the lender may require you to pay off those positions using the funds from the new HELOC or home equity loan.
For a quick automated computation, try using a CLTV calculator. Your CLTV should be less than 80% to qualify for most home equity products. Some lenders might offer products with CLTV caps at 90% or even 125% of the property value, but these loans often have challenging qualifying criteria.
Sometimes the term “credit score” is used interchangeably with FICO, but FICO is just one popular credit score brand published by Fair Isaac Company. Experian, TransUnion, and Equifax are the three major credit bureaus in the US. Each publishes its credit score based on data it collects from public and private financial institutions about consumer financial behavior.
As most homeowners know, a “good” credit score is a prerequisite for many financial products; home equity loan and HELOC requirements are no different in this regard. While eligibility requirements vary significantly from institution to institution, it’s not uncommon for big banks to require a credit score of 720 or higher for home equity borrowers. Other lenders may offer competitive rates for borrowers with a FICO score of 680 or higher. Since the 2008 financial crisis, lending standards have tightened a lot. Consequently, it has become very challenging for homeowners with a credit score below 680 to find lenders who will offer home equity financing.
Debt to Income (DTI) Ratio
While high credit scores will put you in a lender's good favor, another factor that will significantly improve your application is a low debt-to-income (DTI) ratio. Your DTI captures how much of your monthly gross income is committed to existing debt obligations. Lower DTIs get the best pricing. The magic DTI HELOC requirement (i.e., the cutoff number) for traditional lenders is typically 45% — though some require an even lower DTI.
What is the origin of that 45% cutoff? Well, it's the number Fannie Mae and Freddie Mac currently use in their loan insurance programs. As a result, homeowners above 45% cannot be underwritten with Fannie Mae or Freddie Mac-insured products. Even for non-insured products, it's common in the lending world to adopt the Fannie and Freddie standards as best practice.
For example, if you earn $10,000 per month and want to maintain a debt-to-income ratio of no more than 45%, your cumulative monthly debt obligations should be less than $4,500. Note that cumulative monthly debt obligations only include debts — the total of your monthly loan repayments (for example, mortgage payments, student loan payments, and car payments). It does not include discretionary expenses (even those which might not seem at all discretionary, like your food expenses or phone bill!).
Other factors lenders consider
Lenders also consider your previous history with mortgages when evaluating you against their HELOC Requirements. For example, you likely won't receive loan approval if your recent account includes bankruptcy, foreclosure, or a short sale.
Additionally, most lenders require that the property serves as your primary residence. While some financial institutions offer second home equity loans, the requirements are often stricter, and the loan comes with less favorable rates and terms. A non-exhaustive summary of the essential factors in an underwriter's evaluation of your application includes:
- Bankruptcy history
- Foreclosure history
- Length of employment
- Recent delinquencies
- Undocumented income
- Significant expenses (especially undocumented expenses)