The two main considerations for lenders writing home equity loans are the value of the home used as collateral and the ability of the borrower to repay the loan. Lenders do not write home equity loans that exceed the value of a home and neither do they lend against uninsured properties or homes in a serious state of disrepair. Borrowers must have a good history of paying debts on time and sufficient income to manage payments. Underwriting guidelines reflects the lender's need to determine the suitability of the applicant and the collateral.
Normally, home equity loans come in one of two forms: fixed rate amortizing loans and variable rate home equity lines of credit. Fixed home equity loans normally have terms of 10 or 20 years. HELOCs have a 20-year duration, during which time borrowers can use the revolving line of credit multiple times in the same manner that people use credit cards. Most people take out home equity loans or lines as second mortgages, but they can also occupy the first lien position on a home.
Underwriting guidelines require the borrower to have a debt-to-income ratio below 50 percent and borrowers with low credit scores often have DTI limits of 40 percent or less. To determine DTI, lenders divide the borrower's monthly debt payments into their gross monthly income. For DTI purposes, lenders include mortgage insurance and property tax as debts.
Lenders impose loan-to-value maximums on homes used as collateral. Generally, loans cannot exceed 80 percent of the value of a home. If a first lien exists, the combined LTV of the two loans cannot exceed 90 percent of the value of the home. Some banks limit LTV and CLTV to 60 or 70 percent.
Most bank's home equity underwriting guidelines require borrowers to provide their two most recent payslips to establish their income. Self-employed persons must provide two years of business and personal tax returns.
Lenders examine loan applicants' credit history by ordering credit reports from Equifax, Experian and Transunion. Credit reports cover the previous seven years of the loan applicant's payment history and even one or two late payments effect the FICO score.
During the underwriting process on a home equity loan or line, lenders look at Federal Emergency Management Agency maps to determine whether houses are in flood zones. Many borrowers without flood insurance believe that lenders require them to obtain unnecessary flood insurance. Flood zones change frequently and most borrowers do not realize that they are in flood zones until they apply for new loans. Congress mandates that lenders require people in flood zones to buy flood insurance before approving them for loans.
In some instances people are not approved for loans because they lack sufficient income or have low credit scores. People who are married can apply for home loans individually if one of them has poor credit. Some lenders even suggest leaving non-working spouses off loan applications because, unless they have much higher FICO scores than the working spouse, they add nothing to the application. Most states require non-borrowing spouses to sign loan documents as the owner of the home, but this does not necessitate them being listed as a borrower.
- The Federal Reserve Board: What You Should Know About Home Equity Lines of Credit
- Wall Street Journal: Prime Rate Frequently Asked Questions
- Financial Web: Some HELOC Fast Facts
- ACBS: Real Estate Appraisals
- National Flood Insurance Program: About the National Flood Insurance Program: When Insurance is Required
- Chase: Home Value Estimator
- New York Times: Home Equity Loans