Why Is The Debt-To-Income Ratio Important For A Home Equity Loan?

If you have some big expenses, getting a home equity loan is a good option to fund them. If you have home equity, this would mean that you will be charged with relatively low interest on a home equity loan. The lenders look at the equity before granting loans and the borrower’s bank statement to analyze his liquid assets. They also look at the borrower’s debt-to-income ratio to reduce the risk of facing a defaulter. The DTI ratio plays a vital role in deciding whether you qualify for a home equity loan.

Rodnae Productions/Pexels | A home equity loan is a great way to finance your expenses

Here’s everything you need to know about how your DTI can play a role in granting you a home equity loan.

What is Debt-to-income Ratio(DTI)?

The Debt-to-income ratio is the amount from your monthly income that you have reserved to pay off your debt. The debts include mortgages, credit card loans, auto loans, home equity loans, etc. You can divide your total monthly debt payments by your total gross income to calculate your DTI.

What DTI is needed for a home equity loan?

Lenders look for borrowers with low DTIs as this indicates that they have enough income to pay for a new debt after paying for their old obligations. An ideal DTI rate is 43.4%, and a rate lower than this would be more attractive for the lenders. A lower DTI can also help you grant a larger loan or lower interest rate. To improve your chances of getting a home equity loan pay off some of your debts to improve your DTI.

Mikhail/Pexels | Lenders will check your DTI and credit score before granting you a loan.

Is a good credit score important for a home equity loan?

Yes, it is! However, a high DTI can counteract your good credit score resulting in the rejection of your home equity loan. A low DTI and a good credit score increase the chances of getting a loan. 

Is it possible to pay off a home equity loan early?

Home equity loans don’t usually have early payoff restrictions, but discussing this with your lender before signing the final papers is better. However, if a home equity loan has an early payoff penalty, then you should calculate how much interest you would save with a penalty.

Karolina/Pexels | Before applying for a loan, make sure you can manage this additional expense

Final Verdict

When you are considering getting a home equity loan, which will be an additional burden on your gross income, analyze the impact an additional loan payment will have on your monthly budget. Make sure you don’t end up in a situation where it might be difficult to manage your day-to-day expenses. If half of your income is used to pay off the debt, another budget would mean getting yourself in trouble. And if you cannot pay your mortgage due for any reason, you might even lose your home. Therefore, it’s crucial that you aim for a low DTI score before applying for a home equity loan. This way, you will have a better chance at qualifying for a home equity loan, and you will be relaxed that you have the payments you need to pay the monthly debt.