The equity in your home is the difference between your home’s value and the amount of your outstanding mortgage. Technically, the difference is your investment, which you can tap into if you need cash. Many homeowners use their home equity to consolidate debt, make home improvements, or even pay for college. Just how much of your home equity can you borrow?
The answer is that it depends. The loan program, your financial situation, and the lender all determine how much equity you can tap into without selling your home.
The Loan Programs
Each loan program has a different maximum LTV or loan-to-value they will allow. When you tap into your home’s equity, you either do so with a cash-out refinance (a first mortgage) or a home equity loan/line of credit (a second mortgage).
If you choose the cash-out refinance option, you can usually borrow up to between 80% – 100% of your home’s value. It depends on the program:
- Conventional loans – 80%
- FHA loans – 85%
- VA loans – 100%
As you can see, the different loan programs vary considerably. Conventionalloans keep the LTV at 80% to avoid charging you Private Mortgage Insurance. At that point, it may not be worth withdrawing the money because it will cost you more than interest – it will cost you the insurance premiums too. FHA loans already charge mortgage insurance no matter how much equity you have in the home, so they allow up to an 85% LTV. VA loans are just a unique product that allow 100% financing when you buy the home and allow veterans to tap into their equity up to 100%.
If you go the home equity loan or line of credit route, you’ll likely be able to borrow up to 85% of the home’s value. The home equity or HELOC is a second mortgage with a separate interest rate and payment. The closing costs on the home equity loans and HELOCs are often lower than the closing costs on a first mortgage and they are sometimes easier to qualify for than a cash-out refinance.
Your Financial Situation
As is the case with any loan, you have to prove that you qualify for the loan. This means that you can afford the payment and have a proven history of good financial habits.
Lenders will likely look at your mortgage payment history to make sure you make your payments on time. They will also look at your credit score, debt ratio, and the amount of reserves you have on hand. The more positive factors you can provide, the easier it will be to tap into your home’s equity.
This doesn’t mean if you have a credit score on the lower side or a high debt ratio that you can’t tap into your home’s equity, but it may cost you. Lenders base the interest rate and the cost of the loan on your risk level. If you pose a high risk of default, you will pay more for the loan at the closing as well as in the interest rate. If you are a low risk of default, you can expect better and possibly more affordable terms.
Each loan program has its requirements, but each lender has requirements too. Lenders can add their own rules to make sure that you can afford the loan and are a low risk of default. Just as when you purchased your home, it’s a good idea to shop around and find a lender with the least restrictive guidelines so that you can get the loan you need.
Choosing to tap into your home’s equity can be a beneficial way to help you financially. Explore all of your options to make sure you choose the one that will cost you the least amount of interest and make the most sense in the long run.