Requirements for a home equity loan or HELOC in 2022

Your home might be your most valuable asset, but when you need cash, you’re probably not going to start ripping up your granite countertops and hardwood floors to sell as scraps. Instead, you might look into taking out a home equity loan or a home equity line of credit (HELOC). 

Doing so can help you access cash based on the equity you’ve built up over the years. That could be from paying down your mortgage every month, or maybe you’ve enjoyed a significant rise in home value during the real estate boom across much of the U.S. and Canada the past couple years. 

Accessing this equity from a home equity loan or HELOC can then give you the flexibility to make personal finance decisions that make sense for you and your family.

Maybe you’re a relatively new homeowner who wants to access cash to pay off higher-interest debt, like student loans or credit card balances. Others might want money for an investment, and some might want money for retirement spending, without having to move. 

Whatever your reason might be, a home equity loan or HELOC might help improve your personal finances or enhance your lifestyle. To help you figure out what might work for you and what you need to do to qualify for a loan or credit line, we’ve put together this handy guide.

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Home equity loans vs. HELOCs vs. other ways of accessing equity

You might think terms like home equity loans and HELOCs are interchangeable, but they’re apples and oranges. Either way, though, you’re borrowing against your home. There’s a risk that if you can’t pay the money back, the lender could foreclose on your home. So, you should be sure you know what you’re getting into before taking on this type of debt.

The key difference is that a home equity loan is typically provided as a lump sum, whereas a traditional HELOC provides you with a line of credit that you can access at your own pace, rather than all at once. 

Another difference is that a home equity loan can have either a fixed or variable interest rate, whereas a HELOC rate is typically variable. Some borrowers might prefer knowing their long-term interest rates when taking out a fixed-rate loan, whereas others might be willing to see where the market goes with a variable rate.

The amount you can borrow can also differ between a home equity loan and HELOC. In Canada, you can typically borrow up to 65% of the value or purchase price of your home with a HELOC, whereas you can go up to 80% with a home equity loan.

Each way of tapping into your home’s equity can have its advantages, it just depends on what works for your personal finances. For example, if you want money for retirement, you might prefer a HELOC, where you can draw from your credit line as needed. If you want money for an investment, you might prefer to take out a large lump sum through a home equity loan. If 

But don’t confuse home equity loans with reverse mortgages. A home equity loan is like a second mortgage, which you generally pay back monthly, similar to your first mortgage. In contrast, a reverse mortgage typically does not require monthly payments but has certain repayment restrictions and is meant for older homeowners.

New options have also emerged that sort of sit in the middle of these different ways of accessing your home equity. For example, the Fraction Mortgage provides a lump sum upfront like a home equity loan, but the monthly payments are optional*, so you can gain some of the flexibility of a traditional HELOC. And unlike a reverse mortgage, there are no age restrictions (other than being a legal adult in your jurisdiction). ‍

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What are the requirements for a home equity loan or HELOC?

Existing equity

Even if home equity loans and HELOCs are apples and oranges, they’re both types of fruit. So, while the specifics differ —  and each lender can have its own requirements — you’ll likely come across very similar categories either way. Some of the top areas lenders look at for home equity loans or HELOCs include:

If you want to tap into your home’s equity, it matters how much you already have. Even if your home is worth $1 million, that doesn’t mean you own $1 million in equity. Perhaps you still have $700,000 left on your mortgage, meaning the remaining $300,000 is your existing equity. Put another way, you own 30% of the $1 million value of your home.

In general, the more equity you’ve built up in your home, the more money you can often qualify for when taking out a home equity loan or HELOC. Lenders also might have their own requirements regarding the percentage of equity you need to own before you qualify.‍

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Property debt

Related to looking at existing equity, lenders will also likely look at your property debt to see if you can afford to take on more loans. One key metric: your combined loan-to-value (CLTV) ratio. 

A CLTV adds up your existing property debt, like your first mortgage, plus the value of the new home equity loan or HELOC you want to take out. That total then gets divided by your home’s value, leaving you with the percentage that your combined debt would consume.

Going back to the earlier example, if you had a $700,000 mortgage on a $1 million home, that loan would be 70% of the total value. But if you also wanted to take out a $100,000 home equity loan, that combined $800,000 would equal 80%. 

To qualify for a home equity loan or HELOC in the U.S., lenders often want your CLTV to be below 85%, if not 80%. Keep in mind that Canada has stricter limits on HELOCs, which can account for 65% of your home’s value, compared with 80% for home equity loans.

Also note that even if you have a small amount left on your first mortgage, your new lender might require you to pay off your existing mortgage with their new loan.‍

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Debt-to-income ratio

Not only do lenders want to know how much debt your property has, but they also want to take a closer look at any other sources of debt in relation to your ability to pay back loans. So, they calculate your debt-to-income (DTI) ratio. To find this number, add up the monthly payments on all your sources of debt — potential home equity loan payments, student loans, credit card debt, car payments, etc. Then, divide that amount by your monthly income.

If your debts total $3,000 per month and your income totals $10,000, your DTI would be 30%. Lenders have varying requirements on what DTI they’ll accept, and not every situation has such straightforward DTI calculations, like when there’s no required monthly minimums.

Still, DTIs often need to be somewhere in the ballpark of 40-50% or less, but much can depend on your specific circumstances and those of the lender.

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Credit score

Your credit score also plays a role in determining your eligibility for a home equity loan or HELOC, especially when it comes to figuring your interest rates. The exact credit score you need to qualify depends on factors like where you’re located (keep in mind Canada and the U.S. have slightly different credit score systems), the specifics of the loan you’re trying to qualify for, your DTI ratio, and more.

In general, the higher your credit score, the more likely you’ll be to qualify for a loan at a competitive rate. Ideally, you would have a credit score that’s deemed to be at least “fair” by credit rating agencies, if not “good.” A low score doesn’t necessarily mean you can’t qualify, but the path then generally wouldn’t be as straightforward.‍

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What are the rates for a home equity loan or HELOC?

The exact rates for a home equity loan or HELOC can vary based on factors like your location, the lender, your credit score and more. Plus, HELOCs typically have variable rates, so what you start at might not be where you end up. But it’s good to know what average rates are so you can see where you stand. 

In the U.S., as of February 2022, borrowers pay an average of 5.96% for a home equity loan and 4.27% for a HELOC, according to calculations by Bankrate.

In Canada, rates are generally a little lower. However, the interest rate environment has been unusual in recent years, given factors like central banks trying to protect economies from pandemic-related shocks. With inflation on the rise, however, interest rates will likely go up in the near term. ‍

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How do I apply for a home equity loan or HELOC? ‍

Applying for a home equity loan or HELOC is often similar to applying for a traditional mortgage. But in addition to filling out an application and going through a credit check, you also often need an appraisal to see how much your home is worth now. That way, if your home has gone up in value since you first bought it, you might be able to tap into more equity.

To get the loan or line of credit, you may be able to go back to the same financial institution you first took out a mortgage with to see what they offer regarding rates and terms. Or, you might explore new lenders like Fraction.

With Fraction, you can unlock up to $1.5M of your home’s equity, with optional monthly payments and fair interest rates.*‍

Get your free estimate today. ‍

Disclaimer: Information in this article is general in nature and not meant to be taken as financial advice, legal advice or any other sort of professional guidance. While information in this article is intended to be accurate at the time of publishing, the complexity and evolving nature of these subjects can mean that information is incorrect or out of date. Please consult with a qualified professional to discuss your specific situation and confirm any information.