How Much Can I Borrow with an Equity Loan?
When you apply for a home equity loan, there are three main factors that are going to determine whether or not you can get the loan, and if you can, how much of a loan you can get. As with most secured debts, your lender will be looking at the three main lending criteria which are:
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When dealing with Equity Loans, the LTV Ratio becomes
even more important than ever, as each lender will have it's own maximum
allowable LTV Ratio, and this can differ between lenders. If your
current LTV ratio is too high the lender will not be able to lend to you
at all, so it can be very worthwhile doing some homework and finding
out which lenders have the highest acceptable LTV thresholds.
Credit Score
Your credit score is a fundamental measure of your relationship with credit in the past. If you have a history of paying your bills on time and managing your debts well, your credit score will be high. If you have mised payments, made late payments or defaulted on loans in the past, your credit score will be much lower. Lenders will look at your credit scores from each of the three main credit reporting bureau's: Experian, Equifax and TransUnion. Each of these organisations keeps a track of your credit independently, and you formal "Credit Score" is a combination and average of the three. Most lenders have a minimum credit score they will accept before offering to lend to you, and the higher your credit score the better.
A Low credit score can indicate an inability to makage your finances effectively and as a result can cause your lender to impose higher interest rates or decline your application. A high Credit Score marks you as a "safe risk" and gives the lender comfort that you will be able to make your repayments in full and on time. If you have a low credit score it can be worth looking at ways to increase your credit score before applying for your Home Equity Loan.
LTV Ratio
Your LTV Ratio is a measure of the current amount of equity you have in your property, and for a home equity loan this is vital. If your Loan to Value ratio is too high you may fall over the maximum allowable limit of your lender. Most lenders cap the acceptable LTV for a Home Equity Loan at 80-85% of the property's value. This means that the maximum amount of all debts secured against that home (inclusing your Equity Loan) cannot exceed 80 or 85% of the current value fo the home when the loan is taken out. If it goes above that level later on, it doesn't matter. to take an example, lets say you have a home worth $100,000 at the moment, and you have a mortgage of $70,000 against it. At the moment your LTV Ratio is 70%.
If your lender allows a Maximum LTV of 85% then you will be able to get an equity loan of upto $15,000 at the most, as this would bring the total debt up to $85,000 against a home value of $100,000 (85%). If on the other hand your current mortgage was $90,000, then your LTV Ratio would already be 90% - well over the allowable threshold for the lender and as a result you would not be eligible for an equity loan.
Debt to Income Ratio
This is another important measurement that a lender will look at, as it reflects your ability to service new debt. Essentially your Debt to Income ratio is a measurement of how much of your income is currently committed to paying off other debts, and how much free (or "disposable") income you have. Many lenders ahve a common rule of thumb for Debt to Income of 27-30%, which means that you total debt repayments should not exceed 27-30% of your before tax income - this includes the repayemnts on your Home Equity Loan.
If your example you make $4000 per month before tax, and your mortgage payments are currently $800 per month, then you currently have a Debt to Income ratio of 20%. If your lender has a maximum allowable Debt to Income Ratio of 27%, then your repayments on the equity loan could not exceed another 7% of your before tax income, or $280 per month.
Combining the Factors
A lender will take all of these into consideration when deciding whether to lend to you, and if so, how much to lend you. Lets have a look at how those fcots might combine in a real life situation:
Justin wants to apply for an Equity Loan. He has a good credit score of 720 thanks to diligently paying off his credit cards every month, a home worth $150,000 and a current mortgage of $80,000. his monthly mortgage payments are $850 per month and his monthly income is $3600 before tax. Justin's lender has a maxiumum LTV ratio of 85% and a maximum Debt to Income ratio of 27%.
Based on the value of his home and current debts, Justins lender would normally be able to offer him a home equity loan of upto $47,500 (85% of his current property value, less his current mortgage of $80,000). However, his Debt to Income ratio will cut this down. repayments on a home equity loan of this size would cost another $527 per month (bringing his total debt repayments to $1377 per month - over 38% of his before tax income!
With this in mind his lender calculates what the maximum additional repayments he can afford would be - $972 per month (27% of $3600) and takes off this current mandatory mortgage payments of $850 per month. This leaves a maximum of another $122 per month to pay the Home Equity Loan with.
After doing some quick calculations the lender determines that with the current interest rate available, and the fact that the loan will be paid off over 10 years, a Home Equity Loan of $11,000 would have repayments of $120 per month, and so Justin is offered an Equity Loan of upto $11,000.
Despite having a great credit score and a lot of Equity, as shown by the low LTV ratio, Justin's borrowing capacity is restricted by his lenders maximum Debt to Income ratio. If he were to approach a lender which allowed a higher Debt to Income Ratio of 30%, he'd be able to get a bigger Equity Loan. In this case Justin would be well advised to shop around for other deals considering his strong credit score and high amounts of equity.
