How much equity do you need for a HELOC?

Woman at a laptop asking herself – how much equity do I need for a HELOC?

Please note: Discover® Home Loans offers a home equity loan product, but does not offer HELOCs.

The equity you need for a home equity line of credit (HELOC) depends on the lender and the specific loan terms.

A HELOC loan allows borrowers to use their home equity as collateral, like a home equity loan. A HELOC works similarly to a credit card — once approved for the line of credit, you can borrow up to the amount available and use it for whatever purpose you deem necessary. People often use a HELOC if they need access to large amounts of money to make home improvements or to pay off debt.

But equity requirements are a bit more nuanced than a solid percentage as lenders also take other factors into account.

What to know about home equity for a HELOC

The loan-to-value ratio (LTV) is the most common formula used by lenders to determine equity. The LTV ratio is calculated by dividing the loan amount by the property’s appraised value.
To get a HELOC, you'll need to apply with a lender and have your home appraised to assess value properly.
Although Discover Home Loans doesn’t offer HELOCs, you may be eligible to borrow between $35,000 to $300,000 with a home equity loan.

What is home equity?

Home equity is the difference between what your house is worth in the current market and how much you owe on your mortgage. Making mortgage payments and favorable market conditions can grow your equity.

So, as you pay off your mortgage or make improvements to your home, its value increases, and so does your home equity.

While some people use their home equity as a form of savings or emergency fund, many capitalize on this asset by taking out a HELOC or home equity loan.

How much equity do I need for a HELOC?

To get a HELOC, you'll need to apply with a lender and have your home appraised to assess value properly. The lender then uses a formula to determine how much equity you have in your home. The most common formula is the loan-to-value ratio (LTV). 

The LTV ratio is the loan amount divided by the property's appraised value. For example, if you have a $100,000 mortgage and your home is appraised at $200,000, your LTV ratio would be 50%. Lenders generally approve HELOCs if your LTV ratio is around 80% or less. So, using the example above, owing more than $160,000 on your mortgage could make it difficult to qualify for a HELOC.

However, every lender has different requirements, so it's always best to check with multiple lenders before applying for a loan.

Home equity loan vs. HELOC

Home equity loans and HELOCs are both ways to borrow against the value of your home, but there are some critical differences between the two. With a home equity loan, you borrow a lump sum of money and make fixed monthly payments over a set period.

HELOCs work differently — you're approved for a line of credit that you can draw on as needed, up to a specific limit. This means that you only pay interest on the amount of money you pull from your borrowable limit, and you have more flexibility in terms of when and how you make payments.

Home equity loans typically have lower interest rates than other financing options such as personal loans or credit cards, making them a good choice for major expenses like home repairs or renovations. However, because they're secured by your home, defaulting on a home equity loan could result in foreclosure. 

How to qualify for a home equity loan or HELOC

Qualifying for a home equity loan or HELOC can seem daunting, but it doesn't have to be. By understanding the basics of how these loans work, knowing what you need to qualify, and having sufficient equity, you can start securing the funds you need for your next project.

Credit score

Your credit score plays a vital role in your eligibility for a home equity loan or HELOC. Generally, higher credit scores give you a better chance of getting approved.

A good credit score can also help lower the interest rate on any loan you take out. If your credit score isn't where it needs to be, start by checking your credit report for errors and making sure your payments are up to date.

Income

Lenders want to make sure you can afford the payments associated with the loan, so they look at your total income and other sources such as investments, rental property income, and retirement funds.

When calculating your income, lenders typically only consider verifiable sources of income, including W2s or paycheck stubs.

Debt-to-income (DTI) ratio

DTI ratio refers to how much of your total income goes towards paying off existing debt each month (including your current mortgage). Lenders tend to prefer applicants with lower debt-to-income ratios because this may indicate that you'll have less difficulty making payments on your new loan in addition to current obligations. A good rule of thumb is that if your debt-to-income ratio exceeds 43%, it may be difficult to obtain approval from lenders.

For example, if your total monthly liabilities add up to $2,000, but you make $3,000 per month gross income, your DTI ratio would be 66% ($2,000 divided by $3,000). This may put you at risk of being declined for a HELOC.

Loan-to-value ratio 

The LTV ratio considers the value of your property and compares it with how much money you're asking to borrow from the lender.

The lower this ratio is, the better your chance of getting approved since it can show that there's enough collateral available should something go wrong with the repayment plan. Lenders typically consider applications with LTV ratios up to 90%.

Check current home equity loan rates

If you're interested in a home equity loan or HELOC, remember to start by evaluating how much equity you have available. Continue by considering your credit score, income, DTI, and LTV to determine your qualifications. Lastly, remember to check current rates before selecting a loan. 

Once you're ready, you can get started on your application!

Although Discover Home Loans doesn’t offer HELOCs, you may be eligible to borrow between $35,000 to $300,000 with a home equity loan. Review the requirements for a home equity loan to find out more.