If you have equity in your home, you might think you can borrow it at any time. But that’s not the case. Each loan program only allows you to tap into a certain amount of your home’s equity.
Why do banks care how much equity you take out of your home? It’s simple – it keeps you paying your mortgage. Without any equity, it can be easy to walk away from your debt and your home because you have the cash in hand. This leaves the lender with your home and a large financial loss.
So how much can you borrow? Keep reading to find out more.
The Loan Program Maximum Allowances
Each loan program has a different amount of equity you can borrow. For example, VA loans allow you to tap into 100% of your home’s equity. VA loans are only for veterans, though. If you are entitled to a VA loan, you may be able to refinance up to 100% of your home’s equity. Of course, you have to be able to prove that you can afford the loan. In other words, you must prove that you have a debt ratio that is lower than 41% as well as have a timely mortgage payment history on your current mortgage.
Unfortunately, no other loan program allows up to 100% equity, though. FHA loans allow up to 85% of your home’s current value and conventional loans allow up to 80% of your home’s current value in a cash-out refinance.
If you want to leave your first mortgage alone and take out a home equity loan or home equity line of credit, banks typically allow an LTV up to 85% as well.
Proving What you Can Afford
The above maximums are the maximum that anyone may borrow, but it’s not a guarantee of what you can borrow. You must prove that you can afford the loan. Each loan program has a minimum credit score requirement as well as a maximum debt ratio that you must meet.
- FHA loans – You need a minimum 580 credit score, a maximum housing ratio of 31% and a maximum total debt ratio of 41%
- VA loans – You typically need a credit score of at least 620 and a maximum total debt ratio of 41%
- Conventional loans – You need a minimum 680 credit score, a maximum housing ratio of 28% and a maximum total debt ratio of 36%
- Home equity loans and HELOCs – Second mortgage requirements vary by lender. Each lender makes their own requirements and typically keeps the loan on their books, putting them in charge of what they do and don’t allow
Keep in mind, for FHA and conventional loans, lenders can add their own requirements on top of what the loan program allows. For example, not every FHA lender will allow a credit score as low as 580. Many lenders will want a higher credit score to decrease the risk of default, especially on a cash-out refinance.
How Much Equity Should you Borrow?
The bigger question is how much equity should you borrow? Just because you can borrow up to 85% of the home’s equity with an FHA loan doesn’t mean that you should. First, consider why you need the funds.
- Are you using the funds to make home improvements?
- Are you trying to consolidate debt?
- Are you using the funds for something not related to your home or debt?
The reason you need the funds will help determine how much you should borrow. For example, if you are borrowing the funds for home improvements, it can be a good investment. You invest the money right back into your home, which typically has the benefit of increasing your home’s value as a result. This way you get an instant return on your investment.
If you borrow the funds to consolidate debt, you have some additional concerns. First, consider why you need to consolidate the debt. Did you get in over your head in debt? Are you able to get out of debt by consolidating it? If you are able to get out of debt, are you able to stay out of it? In other words, can you leave those open credit lines alone?
Before you tap into your home’s equity, give it some long, hard thought. If you can get a favorable loan and you need the funds for something important, then it can be a good idea. Just make sure that you read the fine print of the loan and understand the terms before tapping into your home’s equity.