When evaluating you for a loan against your equity, lenders assess you for a warm smile, winning personality, dancing ability and willingness to fetch coffee. Make sure you ask if the loan officer wants cream or sugar.
Just seeing if you're paying attention.
The lending institution considers your creditworthiness when deciding whether to extend a loan and how much of an interest rate you will pay. Your creditworthiness boils down to three things: your credit history, your income and the loan-to-value ratio.
Credit historyCredit bureaus collect information about the amount of debt you have and whether you pay your bills on time. They compile this information into a file called a credit report, and then boil all this down to a number between about 300 and 850. That number is your credit score. Sometimes it's called a FICO score, after Fair Isaac Corp., the company that pioneered credit scoring.
This article describes how to obtain your credit report and understand it. You can buy your FICO score directly from Fair Isaac. Federal law entitles you to one free credit report per year. The report and the score may be bundled together or offered separately.
Your credit report contains:
- Identifying information, such as your name, address and Social Security number;
- Credit history, such as when you opened your accounts, how much you owe, the amount of your credit limits, whether you closed accounts or the creditors closed them, and whether you paid on time;
- Public records, such as whether you have any bankruptcies, foreclosures, liens, repossessions, or legal judgments against you (including failure to pay child support or taxes); and
- Lists of recent credit inquiries.
IncomeLenders want to know how much you make and how long you've been at your job, as well as how long you have been working in your particular field. They will look at your total debt-to-income ratio: How much of your monthly income goes toward paying the mortgage, credit card bills, car payment and other obligations, including the payments on the equity debt for which you are applying. Most lenders want to keep that ratio under 36 percent.
Be prepared to show your lender proofs of income, such as W-2s, tax returns and other earnings statements, or get ready to be turned down or pay a higher interest rate.
Loan to value ratio, or LTVThis is the ratio between what you owe on your house and what it's worth. If your house is worth $100,000 and you still owe $80,000, your loan-to-value ratio is 80 percent, because $80,000 is 80 percent of $100,000. When you bought the house, calculating the LTV was straightforward: the mortgage amount divided by the home's price.
It's more complex when you get a home equity product, because the home's value probably has changed since you bought it. The lender will get an appraisal, or estimate, of the home's current fair market value. Then it will add the current mortgage balance to the size of the equity loan or credit line that you want, and divide that by the home's current value. That results in the new LTV ratio.
Traditionally, equity lenders want to keep your total loan-to-value at 80 percent or less. So, for example, if you owe $100,000 on a house that's now valued at $200,000, you could get an equity loan of up to $60,000. A loan that size would increase your total housing debt to $160,000, or 80 percent of the home's value. But there are lenders that will go higher -- even, in some cases, for more than the value of the home. These are called high loan-to-value (high LTV) loans, and Bankrate's surveys of home equity lenders include lenders who offer them. Expect to pay a higher rate on such loans. You'll only get that loan or credit line, though, if you earn enough to afford the monthly payments.