What disqualifies you from getting a home equity loan?
With the Federal Reserve's benchmark rate hovering at multi-decade highs, borrowers are facing the types of interest rates that make taking on new debt quite painful. In turn, it can be tough to find an affordable route to borrow money for buying a home, a car or even using your credit cards. But while many of today's borrowing options are anything but cost-effective, there are still a handful of potential options that make sense.
One of the borrowing options that has remained relatively affordable is a home equity loan. Thanks to surging home values over the past few years, homeowners have built up record levels of home equity that can be tapped into for nearly any purpose. And because home equity loans are secured by your home as collateral, the average interest rates on these loans are typically lower compared to other types of debt.
As a result, many homeowners have been using home equity loans to take advantage of borrowing at relatively low interest rates. But while home equity loans can certainly make sense, it's important to understand that not every homeowner who applies will automatically be approved. There are factors that can disqualify you from getting a home equity loan — so if you're planning to apply for one, it's crucial to know what can cause your application to be rejected by lenders.
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What disqualifies you from getting a home equity loan?
Here are some common disqualifying criteria for home equity loans as well as some potential solutions for overcoming these hurdles.
Low home equity levels
One of the primary requirements for getting a home equity loan is having sufficient home equity in your home. Most lenders require you to have at least 15% to 20% equity left in your home after factoring in the new loan amount. If your home's value has not appreciated enough or you haven't paid down a big enough chunk of your mortgage balance, you may not qualify for a loan due to inadequate equity levels.
The potential solution: In this case, you may want to postpone applying for a home equity loan until you've built up more equity either through your home gaining more value or paying down more principal on your mortgage.
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Poor credit score
Just as with any other loan, home equity lenders will analyze your credit score and credit history when you apply for a home equity loan. Those who apply with lower credit scores will have a harder time getting approved. And, that's especially true for those with credit scores below 620 or so.
The potential solution: You may want to shop around and find out which lenders will work with those who have lower credit scores or take some time to improve your credit score before applying. As part of that process, be sure to pay all bills on time, pay down credit card balances and fix any errors on your credit report.
High debt levels
In addition to your credit score, lenders evaluate your debt-to-income (DTI) ratio when applying for a home equity loan. If you already have a lot of outstanding debt compared to your income level, taking on a new monthly home equity loan payment may be too much based on the lender's criteria.
The potential solution: The best route is typically to pay down as much existing debt as possible before applying for a home equity loan in order to lower your DTI ratio to acceptable levels.
Unstable income and employment
Income and job stability also factor into the approval process when applying for a home equity loan. If you have an unsteady income stream or have switched jobs frequently, lenders may be wary of your ability to keep up with the new loan payments due to what's perceived as instability related to your employment.
The potential solution: If you want to avoid disappointing news about your home equity loan, it's important to stay at your current job for as long as possible and build up a solid history of steady paychecks before applying.
Issues with the property type
Certain property types like condos, co-ops, multi-family residences, log homes or homes on leased land can complicate the home equity loan approval process. These non-traditional property types often face extra scrutiny during the lending process, and in certain cases, it could cause your home equity loan application to be rejected.
The potential solution: Shop around before applying and check with several lenders to see which ones may be more amenable to lending on your specific property type.
Insufficient home value
If the appraised value of your home is lower than expected, it may not provide enough collateral to make the lender comfortable extending a home equity loan against it.
The potential solution: Get multiple appraisals to identify the highest possible valuation. Making renovations and cosmetic upgrades to increase your home's market value can also help.
Outstanding tax liens and judgments
Having an outstanding federal tax lien, court judgments or unresolved issues with creditors can be an impediment to securing approval on a home equity loan application. Lenders want to see a clean financial track record, and in certain cases, the liens on your property can make it difficult or impossible to borrow against it.
The potential solution: Resolve any outstanding liens, judgments or creditor disputes before applying for a home equity loan in order to present a clear financial picture for lenders.
The bottom line
While home equity loans represent one of the most affordable borrowing options in today's high-interest rate landscape, not every homeowner will qualify to borrow with this option. But by understanding some of the key reasons for denial and proactively taking steps to overcome those hurdles, you can potentially improve your chances of approval. As with any major financial decision, though, doing your research upfront can pay dividends in the long run.
