23 Nov Qualifying for a home equity line of credit

Q. My house is worth about $400,000 and my mortgage is $200,000. I want to use a home equity line for home improvements. How much would I qualify for, and how much should I spend?
— A borrower be

A. Lenders look at several factors when qualifying a homeowner for a home equity line of credit.

A big one relates to your property and the amount of debt on your property, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway.

The general rule is an 80 percent loan-to-value (LTV) ratio, he said.

In your case, the maximum total debt on a $400,000 property would be $320,000, he said. Just note that the lender generally requires an appraisal to verify the fair market value of your home.

The rules regarding home equity borrowing have become more stringent since the real estate recession, and lenders are now much more diligent with their lending standards, said Michael Pirrello, a certified financial planner with Mill Ridge Wealth Management in Chester.

He said lenders are also looking for borrowers with high credit scores. A credit score in the high 600s is the minimum score most lenders will consider, and ultimately, a credit score over 700 will be more desirable form a lender’s standpoint, Pirrello said.

The lender will also look for a “front-end debt-to-income ratio” of no more than 28 percent, McCarthy said.

“They look at your total monthly housing costs — mortgage principal and interest payments, plus monthly property taxes, homeowner insurance and association/maintenance fees, if any,” he said.

Then they will look for a total debt-to-income ratio of 36 percent, McCarthy said. For this, the lender will look at your total monthly debt obligations divided by your total (gross) monthly income. The debts would include all recurring monthly obligations, including the current mortgage and any home equity debt, car loans and leases, credit cards, student loans, alimony and child support.

On the income side, they will look at the last two months paystubs for W-2 employees. For folks paid on a Form 1099 or self-employed individuals, they will require your last two years federal income tax returns and will generally use your Adjusted Gross Income (AGI) for the two years divided by 24, he said.

For both ratios, you take the total of the debt divided by your total income.

McCarthy said if you want to estimate how much home equity you might qualify for, take your monthly (gross) income and multiply it by 28 percent and 36 percent. Then compare your current monthly housing costs to the 28 percent figure and your total monthly debt obligation payments to the 36 percent figure.

“If these figures are lower, then you have capacity to take on some home equity debt,” McCarthy said.

In terms of how much to spend on home improvements, you’d want to make sure you don’t put too much money into your home that your local real estate market can’t support the value of your investment, Pirrello said.

“You would not want to put $100,000 into your home, yet not increase the value substantially,” he said.

If your neighborhood only supports a $400,000 value, then you need to keep a measured approach on your spending on improvements or you will not get your money back on your investment.

“Additionally, keeping more equity in your home is more financially prudent, so just because you may qualify for that $120,000 HELOC, it doesn’t mean you should spend it all, thereby reducing your equity in your home substantially,” Pirrello said.

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This story was first posted in December 2015.