Fund Home Renovations with a Home Equity Loan

Are the projects on your home renovation wishlist starting to add up? You want to update the bathroom, fix faucet leaks, paint the bedroom, replace the rug, build a patio, and maybe even put in a small pool. However, you don’t have extra cash just sitting around, and the funds in your savings account aren't enough to cover the home improvements.

A home equity loan is one way that you might be able to get those projects done when you don't have excess cash on hand. However, you’re not limited to using a home equity loan solely for home improvements. It can also be used for debt consolidation, education expenses, medical bills, business ventures, or other real estate purchases. Let’s explore what a home equity loan is and how it works.

How does a home equity loan work? 

A home equity loan is a type of loan that allows homeowners to borrow against the equity they have built up in their property. Equity is the difference between the current market value of your home and the outstanding balance of your mortgage. Essentially, a home equity loan converts a portion of your home’s equity into cash.

Home equity loans are often referred to as second mortgages because they are secured by the borrower's home, just like the primary mortgage. These loans may come with fixed interest rates and fixed repayment terms, providing borrowers with predictable monthly payments.

How much can you borrow with a home equity loan?

The amount you can borrow with a home equity loan is determined by several factors and varies from person to person based on their unique financial situation. Below are some factors that lenders at Southside Bank review when looking at a home equity loan application:

Loan-to-Value Ratio (LTV)

The loan-to-value ratio is calculated by dividing the amount of the loan by the appraised value of the home. For example, if your home is appraised at $300,000 and you are looking to borrow $60,000, your LTV ratio would be 20%. Most lenders have a maximum LTV ratio they are willing to accept, which usually ranges from 70% to 80%.

Debt-to-Income Ratio (DTI)

Lenders will assess your debt-to-income ratio, which is the percentage of your monthly income that goes toward paying debts. A lower DTI ratio indicates better financial health and a higher capacity to take on additional debt. Most lenders prefer a DTI ratio of 43% or lower, though some may allow higher ratios depending on other factors. 

Southside Bank Mortgage Loan Officer Emmanuel Terrazas says, “The DTI allows us to determine if the applicant can afford a new home equity loan along with minimum payments for debts showing on their credit report. If their DTI is too high, they have the option to use proceeds from the home equity loan to pay off debts at closing (which will lower the debt we count in their DTI).”

Credit Score

Your credit score plays a significant role in determining how much you can borrow and the interest rate you will receive. A higher credit score indicates to lenders that you are a lower-risk borrower, which can result in a higher loan amount and more favorable interest rates. Generally, a credit score of 700 or above is considered good, but each bank has its own criteria.

Income and Employment History

Stable income and a solid employment history can enhance your borrowing capacity. Lenders want to ensure that you have a reliable source of income to make the loan payments. Documentation such as pay stubs, tax returns, and employment verification may be required during the application process.

Conclusion

A home equity loan can be a valuable financial tool for homeowners looking to leverage the equity in their property. Understanding the factors that determine how much you can borrow is essential for making informed decisions and securing favorable loan terms. By considering your home’s equity, credit score, DTI ratio, LTV ratio, and income, you can better navigate the borrowing process and maximize the benefits of a home equity loan. 

If you want to learn more about home equity loans or begin the application process, you can reach out to one of our local lenders at southside.com/personal/mortgage/meet-our-lenders.