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The housing boom that occurred over the last several years helped drive a significant uptick in home equity, resulting in the average homeowner having about $319,000 worth of equity in their home right now. Not every homeowner has that much equity in their home currently, though. For example, those who bought in the last year or two may not have had enough time to make much of a dent between what they owe on their mortgage and what their home is worth. Others may own homes in markets where home values haven’t increased significantly, leaving them with less equity than the average.
But whether you’ve got a six-figure sum of equity or less, if you need to borrow money, a home equity line of credit (HELOC) can be a good option to consider. HELOCs allow you to turn a portion of your equity, which is the difference between your mortgage balance and your home value, into a revolving line of credit you can draw from as necessary for up to 15 years, depending on the HELOC term you choose. HELOC rates also hit a two-year low this week, making this a great time to consider this borrowing option.
What if you have a low amount of equity, though? Can you still take out a home equity loan?
Find out what HELOC rates you could qualify for here.
Can I take out a HELOC with low equity?
In most cases, having a low amount of equity in your home won’t automatically disqualify you from being approved by a HELOC lender. That said, most lenders typically require you to have at least 15% to 20% equity in your home after accounting for the HELOC, meaning you’d need more than that amount of equity before applying. Here’s how that works.
Let’s say your home is appraised at $400,000 and your remaining mortgage balance is $320,000. In this case, your current equity is $80,000 (or 20% of your home’s value). If a lender requires you to maintain 20% equity after the HELOC, they would only allow you to borrow up to $40,000. This calculation ($400,000 × 80% = $320,000 maximum total debt, then $320,000 – $320,000 current mortgage = $0 available for HELOC) demonstrates why low equity can significantly limit or eliminate your HELOC options.
Some options may still exist for homeowners with lower equity positions, though. Certain lenders may offer HELOCs to borrowers with as little as 10% equity, for example. However, your HELOC options will likely be more limited and potentially more expensive if you’re in a low equity position. Lenders view low-equity HELOCs as higher risk since there’s less of a cushion if property values decline. As a result, you might also face stricter qualification requirements regarding your credit score, debt-to-income ratio and income stability.
Does it make sense to take out a HELOC with low equity?
Whether or not it makes sense to take out a HELOC with low equity depends on a variety of factors, including what you’re using the HELOC for. If you know, for example, that you’ve got a big expenditure coming up in a few months and you need a low-rate way to borrow money, a HELOC can help fund it — and with the average HELOC rate sitting at about 8.12% currently, it’s a better option than taking out a high-rate credit card or personal loan in today’s rate environment.
A HELOC could also make sense if you think you may need to borrow money in the future but aren’t sure if you’ll use it. After all, if you don’t draw from the line of credit during your draw period, you won’t have to make any payments during the draw period. But if you took out a lump-sum home equity loan, you would need to repay it in full, with interest, making a HELOC the better choice for most people.
“That’s the beauty of a HELOC,” GO Mortgage Sales Manager Adam Neft says. “In most instances, you don’t pay unless you draw on it.”
However, there may be times when it doesn’t make sense to get a HELOC when you have low equity. For example, if your home’s equity is so low that you can’t qualify for a top rate, it might not be worth pursuing — especially if you have other borrowing options to consider. Or, if your low equity amount won’t allow you to access the full amount you need, it may not be worth the cost or the fees to pursue this type of borrowing. A personal loan or another type of loan could make more sense in these situations.
The bottom line
Homeowners with low equity aren’t necessarily disqualified from getting a HELOC. There may still be options to consider in these cases. However, borrowers with low equity could end up paying more for their HELOCs in the form of higher rates or fees, as there’s more risk to the lender. You’ll also have to meet your lender’s requirements to qualify, so if you don’t have enough equity to do that, you may have to consider other options.
