Understanding The Home Equity Loan Approval Process

Getty Images/Greg Hinsdale

You hear a lot about tapping home equity – borrowing against the worth of your home – for cash these days. Unfortunately, getting approved for a home equity loan or home equity line of credit (HELOC) isn’t always easy. Although they are akin to mortgages, the rejection rate is much higher: Almost half of HELOC applications are denied these days, according to Home Mortgage Disclosure Act data.

If you’re thinking about tapping into your home equity, here’s a step-by-step guide on how to navigate the home equity loan application process smoothly and ensure your chance of approval.

What are home equity loans and HELOCs?

A home equity loan and HELOC are the two most common ways to borrow against your home’s value. Both are a form of second mortgage, but they differ in some significant ways.

A home equity loan provides a lump sum of money at a fixed interest rate. You have to repay it over a set period with regular fixed payments. The loan is ideal for homeowners who need a specific amount for a large, one-time expense.

A HELOC offers a revolving line of credit, similar to a credit card, with a variable interest rate. The line of credit gives borrowers flexibility, as they can withdraw money as needed during a set period, typically 10 years; they can repay those funds, replenishing the balance, and then draw again. Eventually, this period ends, and they must start paying back the borrowed funds in full.

Steps in the home equity loan approval process

Applying for a home equity loan involves several key stages on the road to approval. Here’s a detailed breakdown of each step in the process.

1. Determine your eligibility

Before you apply for a home equity loan, make sure you can meet the minimum requirements:

• Home equity: You should have at least 20 percent equity in your home, though some lenders will allow you to have as little as 10 percent. Even better if your stake equals over half of your home’s worth (aka being “equity-rich”): the more you own, the more you can borrow.
• Credit score: A credit score in the mid-600s is usually the minimum to get you approved. But a a score in the 700s will get you the best rate and terms.
• Debt-to-income (DTI) ratio: Your DTI measures your gross monthly income relative to your monthly debts. Lenders want your DTI to be no more than 43 percent, as it shows your obligations are less than half your earnings, and you have the wherewithal to take on additional debt.
• Combined loan-to-value ratio (LTV): Your CLTV compares the amount you want to borrow against the value of your home, factoring all the loans backed by your home (including your mortgage). Lenders typically limit the CLTV to be 80-85 percent. The rationale: You maintain a cushion of untapped equity, so that if property values fall, you won’t end up owing more on the home than it’s worth.
• Income: While there are no set income requirements to get approved, you have to demonstrate that your income is stable and consistent enough to handle the loan payments comfortably. Lenders will also verify how long you’ve been in your current job.

2. Research and compare lenders

Compare offers from at least three lenders, including banks, credit unions and mortgage/home lending companies; be sure to include both bricks-and-mortar and online lenders. Each lender sets its own interest rates and its own fees, which vary greatly; so be sure to compare the advertised APR, which takes both into account.

3. Submit an application and documents

Depending on the lender, you will be able to complete the application online, on the phone or in person. This process typically includes providing personal information, details about your home, and financial documents (see “Information you must provide” below). The lender will check your credit history, with its list of your accounts and debt obligations, and credit score. But you should be prepared to provide proof of income and homeownership.

4. Go through underwriting

The underwriting review is one of the most critical steps in the home equity loan process. During this phase, the lender evaluates your creditworthiness, home value, assets, debts and ability to repay the loan. They will verify everything in the paperwork you submitted, and may request additional documentation.

5. Receive loan approval and close your loan

Once approved, you’ll receive a loan estimate outlining the terms of your HELoan or HELOC and the various closing costs. After agreeing to them, you’ll attend a closing meeting to sign the final documents and pay any fees or upfront charges. Funds are typically received within a few business days after that.

Information you must provide for a home equity loan

To apply for a home equity loan, you will have to gather several documents to verify your identity, income and assets. Here is a checklist of what you need:

• Proof of identity/personal information: You will need to provide your Social Security number, date of birth and a government-issued photo ID (such as a driver’s license or passport).
• Income documentation: Depending on your employment status, you may need recent paystubs, two of the most recent years of W-2s, business and federal tax returns, your Social Security income or pension award letter, investment statements, or rental income agreements.
• Property information: Among the documents you should have on hand are the homeowners insurance declaration, property tax statement, home title and title insurance policy (if any) and a record of your flood insurance (if your home is in a flood zone).

Tips for a smooth home equity loan approval

No one wants to be turned down for a home equity loan, or any loan for that matter. But the getting financing seems to be getting harder these days.

Here are some tips on how to improve your chances of getting approved for home equity funding:

• Check your credit score: Ensure your credit report is accurate and resolve (or at least dispute) any inaccuracies before you apply. Higher scores can increase your chances of approval and help you secure better rates and terms.
• Lower your debt: Is a lot of your monthly income going right out again to pay ongoing obligations? Improve your eligibility by paying down outstanding balances as much as you can. Doing so will also improve your credit score.
• Get your paperwork in order: Have your W2s, primary mortgage details, and all relevant documents and information ready ahead of time to speed up the process. The sooner you get it in, the sooner they start underwriting.
• Stop shopping: Before your loan closes, don’t make large purchases or take on big new debts.

FAQ

• How long does it take to get a home equity loan?
  

  The time it takes to get a home equity loan typically ranges from two to six weeks, though it varies depending on the lender. Avoid delays by getting your documents ready and checking your credit score ahead of time. Responding quickly to lender requests can also speed up the process. Some online lenders, like Better or Figure, promise decisions in as little as a few days — provided you get them all the paperwork promptly (Better, for example, mandates 24 hours after you apply).

• Why would a home equity loan be denied?
  

  Poor credit, a high DTI, insufficient equity or unstable income are among the reasons applicants may not be approved for a HELOC or home equity loan. If you fall into this boat, focus on the reason for the denial and try improving it — like increasing your equity stake (by paying down your mortgage) or improving your credit score before reapplying. Or try another lender. Remember, just because one denies your loan, it doesn’t mean another one will.

• Who’s most likely to get a home equity loan?
  

  Home equity loan borrowers tend to be a well-heeled, highly creditworthy lot, with qualifications far above the minimum requirements — or even the average homeowner’s. The best person to take out a home equity loan has paid off a large chunk of their mortgage, owning at least half of the home outright. That often means they’ve owned the home a while, for a decade or so (or they bought it mostly with cash). Their debt-to-income ratio is around 40 percent. But what really sets them apart is superb credit: We’re talking about 750 or higher.