This calculator enables homeowners to estimate how large of a credit line they may qualify for given the appraised value of their home & any outstanding mortgage debt they have against the property. Various lenders allow borrowers to qualify for different Loan-to-Value (LTV) ratios. Lenders which allow borrowers to tap a higher percent of their home's value typically charge higher rates of interest to protect against the risk of default.
Current San Diego HELOC rates from our lender network are published under the calculator to help you calculate using real market data and obtain a favorable rate on your home equity line of credit.
Credit Line Qualification Calculator
Current San Diego Home Equity Line of Credit Rates
The following table highlights current HELOC rates from lenders serving the San Diego area.
Primary Strategies to Leverage Your Home Equity
One of the advantages of homeownership is building significant wealth. The longer you pay your mortgage, the greater home equity you gain. Home equity also increases when your property’s market value appreciates over the years.
The current appraised value of your home minus what you owe on your property is known as home equity. For instance, your home’s current value is $400,000. If you owe $250,000 on your mortgage, your home equity is worth $150,000, which is around 38% of the property’s value.
According to ATTOM Data Solutions, in Q4 of 2020, approximately 30.2% (17.8 million) out of 59 million mortgaged houses in the U.S. were equity-rich. Being equity-rich means the amount you owe on the property is 50% or less than your home’s estimated value.
Homeownership is a long-term investment because it takes time to pay off a mortgage. And unless you sell your home, money often remains illiquid for years in your property. However, there are ways you can leverage home equity without having to sell your house. When you borrow against home equity, you can use the loan proceeds for important expenses, such as substantial home improvements, your child’s college education, or for medical expenses.
Our article will walk you through the three main ways you can borrow against home equity. These include taking a home equity line of credit (HELOC), a home equity loan (HEL), and a cash-out refinance. By understanding how these options work, we hope to help you make better financial decisions.
General Requirements for Leveraging Home Equity
Homeowners can tap home equity by applying for a home equity loan, HELOC, or a cash-out refinance. For starters, you must understand the basic requirements in order to take advantage of these options. While each lending product has their own unique benefits and challenges, they all share these common guidelines:
- The borrower’s property must be appraised.
- The borrower must satisfy the loan-to-value (LTV) ratio as per the lender’s requirement.
- The borrower must have a good credit score, (700 and above is preferred).
- The borrower must have a good debt-to-income ratio (under 50%), have a good income stream, and demonstrate the ability to repay the loan.
Equity Financing Uses Your Home as Collateral
When you leverage equity for loan collateral, you are using your house as the guarantee against default. Thus, if you fail to keep your end of the bargain, such as miss payments, the lender can foreclose your home. This is the risk you take when you decide to borrow against your home equity. Be sure to prioritize loan payments to avoid losing your property.
Calculating Loan-to-Value (LTV) Ratio
Property appraisal is required to confirm the actual market value of your house. When borrowing against home equity, one of the first things your lender reviews is the loan-to-value ratio or LTV. LTV is basically a measurement that compares the loan amount and the market value of the home. To calculate your LTV ratio, you simply take the remaining mortgage amount (current loan balance), then divide it by the current appraised value of the property.
LTV = (Current loan balance / Current appraised value of property) x 100
For example, suppose you owed $150,000 on a home with a current appraised value of $500,000. If you take 150,000 and divide it by 500,000, the result would be 0.3. When we multiply 0.3 by 100 to convert it to percent, the LTV ratio is 30%.
= (150,000 / 500,000) x 100
= 0.3 x 100
In this example, it shows you’ve paid over half of your home’s market value. The low LTV makes you a perfect candidate for obtaining a cash-out refinance or a second mortgage (such as a HELOC or home equity loan).
The LTV is key in deciding the specifics of all fixed-rate, equity-based mortgages. As a borrower, you must ideally approach this situation with a lower LTV. Generally, most lenders prefer borrowers to have 80% LTV to be eligible for a cash-out refinance. This also applies to HELOCs and home equity loans. Many lenders also offer lower, more favorable interest rates to those with an LTV of 80% or less. This means borrowers must have at least 20% equity in their homes.
What if my LTV is over 80%? If this is the case, you may still be granted a loan offer. However, expect your rate to incrementally increase. Moreover, applicants with over 80% LTV should generally have pristine credit ratings, cash on hand, and a strong credit history to back them up. These and other attractive financial traits may allow lenders to overlook the risks associated with a high LTV.
Calculating Combined Loan-to-value (CLTV) Ratio
Combined loan-to-value (CLTV) ratio calculates the ratio of all secured loans to the appraised market value of a property. CLTV ratio is distinct from the usual loan-to-value (LTV) ratio because it accounts for both the primary and second mortgage when assessing a loan. LTV ratio, on the other hand, only calculates for the primary mortgage.
To calculate the CLTV ratio, you must add the amount of the desired loan, and/or any additional loan balances, to the amount of the loan balance. Then, we divide that sum by the current appraised value to arrive at the CLTV ratio. For instance, to assess a borrower’s eligibility for a HELOC, let’s use our first example.
CLTV = (VL1 + VL2) / Current appraised value of property
VL = Value of the loan
Suppose you want to borrow $90,000. We’ll add this amount to the $150,000 loan balance, which amounts to $240,000. Then, we’ll take $240,000 and divide it by $500,000. The resulting CLTV ratio is 0.48 or 48%.
= (90,000 + 150) / 500,000
= 240,000 / 500,000
= 0.48 x 100
Likewise, if you had other liens on the property, it would be included into the CLTV ratio calculation. For example, if you add an additional lien of $50,000 to the example, the calculation for CLTV would look like this:
= ($90,000 + $150,000 + $50,000) / $500,000
= 29,000 / 500,000
= 0.58 x 100
In this example, your CLTV ratio is below 80%, which makes you a good candidate for a HELOC or a home equity loan.
Maintaining the Required Level of Equity
For equity-based financing, lenders typically want borrowers to retain between 10% to 20% of their home’s earned equity. This is a security measure that helps lenders mitigate the risk of servicing your mortgage. This is equivalent to an LTV limit of 80% to 90%. For example, if a lender wants you to maintain 15% equity, that means you should maintain $75,000 out of its $500,000 market value.
If you owed absolutely nothing on the house, you could borrow a maximum of $425,000. Using the first example, if you had $150,000 existing balance, and a second mortgage of $90,000, you would have a total debt load of $240,000. This is well below the CLTV limit of 85%.
Besides the requirements mentioned above, you must also consider the following factors before taking an equity-based loan:
- Consider the timeline to complete loan payments: Ask yourself how long you can realistically pay back the loan. It also matters that you stay long-term in the house to complete the payment. If you move too early, specifically if you took a HELOC or HEL, you’ll have to pay your first and second lender immediately.
- Know your current mortgage interest rate: Depending on your rate, you should make sure to secure a lower rate for a cash-out refinance. Second mortgages, on the other hand, will typically have higher interest rates than primary mortgages. But the better your credit score is, the more favorable rate you can get for a second mortgage. Factor in the rate to estimate how much your loan payment will cost.
- Decide whether you prefer a fixed or flexible term: When you choose a fixed term, that means you’ll borrow a definite amount from your equity. This is the case when you take out a cash-out refinance or home equity loan, which should be paid within the agreed term. But if you want a flexible term, you can take a HELOC which provides a revolving line of credit. There are also hybrid second mortgages that have the flexibility of a HELOC, and the stability of payments provided by a HEL.
Other Important Qualifying Factors
Besides LTV ratio, lenders evaluate other financial factors to see if you’re a viable candidate for an equity-based loan. These factors include your credit score and debt-to-income (DTI) ratio, which is similar to when you take a traditional mortgage. And as with any type of financing, it’s best to improve your credit rating and DTI ratio before you apply for a new loan.
Credit scores are a strong factor for loan eligibility. Lenders generally seek low-risk borrowers, which means they prefer a good FICO score of 700 and above. The higher your credit score, the more competitive rate offers you can receive.
One the other hand, if your credit score is lower, such as the 650-699, you can still be approved. However, expect to receive higher rates. Lenders impose higher rates on borrowers with lower credit scores to mitigate default risk. But if your credit score is less than 630, you might pose too much of a risk for equity-based financing. In this case, you will have lower chances of receiving offers, or you won’t be approved at all.
Lenders will also carefully assess your credit report. Expect them to review your credit history for any late payments or large overdue balances. If you have on-going credit issues, it’s best to settle them before applying for a second mortgage or cash-out refinance. A clean credit record gives you greater chances of securing equity-based financing.
Review Your Credit Report
Remember, consumers are allowed to request a free credit report each year. Make sure to check your credit report before applying for any loan. You can request one each from the three trusted credit reporting agencies in the country: Equifax, TransUnion, and Experian.
Debt-to-income (DTI) Ratio
In addition to having a pristine credit record, lenders evaluate your back-end debt-to-income (DTI) ratio. Back-end DTI ratio is a measurement that compares all of your monthly debt payments with your gross monthly income. DTI ratio is an indicator that helps lenders determine whether you are in good financial standing to take on more debt. A lower DTI ratio suggests you have sufficient income to afford consistent debt payments. On the other hand, a higher DTI ratio means you’re overleveraged, which increases your risk of default.
Generally, lenders want to see 50% or less back-end DTI ratio. Moreover, you might hear financial advisors saying your DTI ratio must not be higher than 43%. Larger lenders usually have the capacity to service mortgages even if the borrower has over 43% back-end DTI. But to be safe, it’s best to maintain a lower back-end DTI ratio to reduce your default risk. To calculate your back-end DTI ratio, you can use the following formula below.
Back-end DTI = Total Monthly Debt Payments / Gross Monthly Income
- Take all your debt payments for the month and add them together. This figure includes your first mortgage payments (with other housing-related costs), credit card debt, car loan, student, loan, child support (if it applies) etc.
- Once you know your total monthly debt, divide this by your gross monthly income. This is the salary you earn each month before taxes.
- The last step is to multiply the result by 100. This converts the figure to the DTI percentage.
As a simple example, let’s say your first mortgage payment is $1,600, your car loan payment is $500, and you pay $300 a month on your credit card debt. This amounts to a total monthly debt of $2,400. If your salary before taxes is $6,000 a month, here’s how to compute your back-end DTI ratio:
1,600 + 500 + 300 = 2,400
= 2,400 / 6,000
= 0.4 x 100
Based on our example, your back-end DTI ratio would be 40%. This is below the 50%, which allows you to qualify for an equity-based loan. But depending on your lender, they might require lower back-end DTI. If you want to reduce your DTI ratio, you should significantly minimize your loan balance. If your DTI ratio is high, try to pay down large credit card balances. Another way to lower DTI ratio is to increase your monthly income.
Comparing Equity-based Loan Options
Once you know you are eligible for equity financing, you should compare each loan option. It’s crucial to know how HELOCs, home equity loans, and cash-out refinances can work to your advantage. Again, they all have unique benefits, but each one also comes with specific drawbacks. The following sections will discuss each loan option in detail.
Home Equity Loan
A home equity loan (HEL) typically comes with a fixed rate for the entire life of the loan. The terms can last for 5, 10, 15, up to 30 years. The borrower receives the money as a one-time lump sum amount. If you need a particularly large amount to cover certain expenses, consider taking a HEL. It’s good option if you have sufficient equity in your home, and your primary mortgage has a fixed low rate. Home equity loans are popular choice for people who are looking to borrow a specific amount quickly.
As with most home loans, a HEL includes closing costs. This ranges between 2% to 5% of your loan amount. The closing costs pay for your home’s appraisal, application fee, documentation, title search and other related processing fees. For instance, you decided to borrow a loan amount of $60,000 from your home equity. Expect your closing cost to be around $1,200 to $3,000.
What is a Second Mortgage?
Home equity loans (HEL) and HELOCs are also called second mortgages, which are loans that let homeowners borrow money against a home with an existing mortgage. Like your primary mortgage, a second mortgage uses the same property as collateral to secure the loan. How much equity you can borrow depends on how much your lender will allow, and how much equity you have in your home.
In the event of default, primary mortgages always receive the first priority. To hedge against this higher risk, second mortgage lenders typically charge a higher rate for HELs and HELOCs than primary mortgage lenders. Finally, taking a second mortgage involves making a separate payment from your primary mortgage. Thus, you must keep track of two mortgage payments each month.
Home Equity Lines of Credit (HELOC)
A HELOC has many more flexible aspects to its structure. It’s a credit line secured by your home which operates similarly to a credit card. A HELOC can even be tied to an account you can draw checks against. You can use the card to periodically run up a balance up to an approved credit limit. HELOCs are paid back within the agreed term, and you only pay interest on the amount you borrowed.
Most homeowners who obtain a second mortgage structure them as HELOCs instead of HELs. The volume ratio in recent years has been roughly 10 to 1. Unlike HELs, the flexibility of revolving credit from HELOCs allows borrowers to withdraw money as needed. If you have prolonged expenses you need to cover, it’s easier to access money with a HELOC.
The Draw Period: HELOCs can come in terms of 10 to 20 years, with a draw period that lasts for the first 10 or 15 years of the term. During the draw period, you can access your funds as needed. You only pay interest on the money you draw, not the entire amount available to you. During this time, you should only withdraw the necessary funds. Then, the balance is repaid during the remaining years of the term, which is usually 10 or 5 years.
Unlike HELs, HELOCs come with a variable or adjustable interest rate. The rate moves along a fixed margin above the prime rate. The unpredictable rate means you must be prepared for higher monthly payments when you pay back your loan. During the repayment period, the interest rate can be fixed, but it depends on your deal with your lender. Moreover, there is an acknowledged risk of overspending during the draw period. This can cause larger payments of principal-plus-interest during when you pay back your loan.
Understanding Your Rates: When you choose a HELOC, you must be aware of caps on your interest rate and how they apply. The lifetime adjustment cap is the highest the interest rate could ever increase, while a periodic adjustment cap refers to how much a rate can increase during a specified time period. Both of these numbers are crucial for obtaining a favorable deal on a HELOC.
Basically, a deal with higher rate caps means your monthly payments can get more expensive over the life of the loan. Thus, try to secure a deal with lower rate caps. While these are basic factors for a HELOC, note that essential elements of a HELOC’s structure and how the lender presents the deal to the borrower will depend on a lot of market-driven factors and the applicant’s financial standing.
HELOCs usually do not impose expensive closing costs. Lenders will ask you to pay a $300 to $400 appraisal fee for the home. They also charge an annual fee of around $100 to maintain your HELOC account.
What is the required LTV ratio for a HELOC? Lenders will only approve a HELOC with an LTV ratio of up to 85%. This means you should have at least 15% equity in your home. Others may require a lower LTV ratio. Thus, you have greater chances of approval if your LTV ratio is lower.
To estimate your credit limit according to the assigned LTV ratio, use the above calculator. To give you an example, suppose you have a remaining outstanding debt of $180,000 on a house with an appraised value of $400,000. This means you have $220,000 worth of equity in your home. The following table shows your maximum debt amount and your corresponding credit limit according to the assigned LTV ratios.
|% of Appraised Value||Max. Debt Amount||Less Existing Loans||Your Credit Limit|
Cash-out refinancing essentially replaces your original mortgage with a new loan that has a more favorable rate and term. Thus, unlike HELOCs and HELs, cash-out refinances are not second mortgages. When you refinance your mortgage, this loan option allows you to borrow an additional amount beyond what you owed on your original loan.
For instance, if your home is worth $400,000 and you owed $200,000 on the loan, and you need to borrow $50,000, you can refinance into and new $250,000 loan balance. The $50,000, which is the difference between your original loan balance and new balance, is given to you as the cash-out.
If you want to obtain a better rate and term, while accessing your home equity, this is a good strategy to take. However, if you’re not keen on refinancing, and just want to borrow against your home equity, it would be better to stick to a second mortgage instead.
Since mortgage refinancing is basically taking a new mortgage, it does not come cheap. The closing costs for cash-out refinancing is usually around 2% to 5% of your loan amount (others even say 3% to 6%). For instance, if your loan amount is $200,000, expect the closing costs of refinancing to be around $4,000 to $10,000. The process is also time-consuming, which can take a month to 6 weeks to close. This makes it slower and more expensive upfront compared to second mortgage options.
In general, refinancing is ideal when market rates significantly fall. If rates are a lot lower now compared to when you locked your fixed-rate mortgage, you might want to consider refinancing. This can save you tens and thousands of dollars in interest over your remaining term.
When interest rates drop hard, such as the wake of the COVID-19 crisis in 2020, homeowners tend to refinance their mortgage. In this case, more people would prefer to take a cash-out refinance instead of a second mortgage.
Hybrid Second Mortgages
With so many loan options, competition has increased to attract borrower’s attention. These days, lenders now offer hybrid loans that take the best attributes from both HELOCs and home equity loans and tailor loan packages for each borrower. Now, you can obtain the flexibility and low cost of a HELOC upfront, with the stability of predictable payments from a home equity loan.
The simple table below can help you compare your basic needs and zero-in on what’s important to you:
|Loan Type||Home equity loan (HEL)||Home equity line of credit (HELOC)||Cash Out Refi|
|funds as needed||x|
|lump sum payout||x||x|
|options to pay interest-only||x|
|pay interest on only amount drawn||x|
|risk of overspending||x|
|risk of property value falling||x||x||x|
|upfront closing costs||x||x|
|potential account inactivity fees||x|
What About Taxes on Equity Financing?
Changes under the 2017 Tax Cuts and Jobs Act (TCJA) have impacted equity-based financing.
Interest paid on many types of equity financing are still tax deductible like in the past. However, since changes enacted in 2017, borrowers can only obtain deductions if they use the loan to build, buy, or substantially improve their home. This wrinkle in the tax law applies to all forms of equity financing.
For example, if you take a cash-out refinance and don’t use the money to improve your house, the interest on that loan will not be tax deductible. You can only deduct interest on the original remaining balance of your mortgage. In the past, you can deduct interest from an equity-based loan regardless of how the money was used.
What does it mean for borrowers today? If you take a HELOC, HEL, or any other type of equity-based financing for home repairs or to purchase and build a home, you can deduct all the interest paid. On the other hand, if you use the loan proceeds for other expenses such as medical bills, college tuition, or a vacation, you cannot take advantage of the tax break.
For more specific details on how this form of financing will directly affect your tax returns, be sure to consult with a certified public accountant (CPA). The IRS website also offers particular information on home equity financing, as well as details about the Tax Reform and it’s general impact to taxpayers.
Is Second Mortgage Interest Tax Deductible?
Prior to the passage of the Tax Cuts and Jobs Act (TCJA) of 2017, homeowners could deduct interest on up to $100,000 in second mortgage debt on their income taxes. This option is still available only if the debt was used to significantly build or improve the home. Homeowners who are married and filing jointly can also deduct interest on up to $750,000 of their first mortgage debt.
After TCJA, the value of mortgage interest deductions has been lowered by increasing the default deduction, eliminating the personal exemption, and capping state and local tax (SALT) deductions at $10,000.
To sum up it all up, here are basic things you should remember before taking equity-based financing:
- With the right LTV ratio, you can likely leverage your home equity. Most people will compare HELOC or HEL, though they are no longer locked into one or the other as the only option. Lenders also offer hybrid second mortgages in the market.
- If your credit score or DTI is off the mark, you can improve it by paying down debt. This can also be improved by consolidating bills or finding other ways to increase your income. Better credit scores mean you’ll receive better financing offers.
- Consider how you’ll use the loan and its monetary impact on your taxes. Remember, how you spend it matters. You can only get a tax deduction if you use the money to substantially improve your home.
- Think about how long you plan to stay in the house. Since it takes time to pay off a mortgage, taking an equity-based loan requires you to stay long-term in a house.
- Factor in the stability of your income. If you think your finances are shaky during the life of the loan, it may not be a wise decision to move forward with equity finance.
- Make sure to compare your options with all other lending products. Decide which ones can address your needs.
Finally, before you take any type of equity-based financing, be sure to take note of the interest rate. HELOCs are impacted by changing interest rates, which eventually increase. However, they cost less money to obtain upfront.
Meanwhile, home equity loans offer stability with predictable monthly payments. It also provides a large lump sum payout if you need a substantial amount at short notice. However, it can be riskier if property values eventually fall over time.
For cash-out refinancing, make sure you can refinance to a lower rate. Ideally, this should be one to two percent lower than your original rate. If your first mortgage originated when rates were on a record low, it would be a good idea to keep it there. This will save you significantly more money than refinancing to higher rates today.
Ultimately, deciding on whether to choose equity-based financing will depend on your individual situation. It will be influenced by your goals, how much you need to borrow, and available loan offers within your reach.
San Diego Borrowers: Are You Unsure Which Loans You'll Qualify For?
We have partnered with Mortgage Research Center to help San Diego homebuyers and refinancers find out what loan programs they are qualified for and connect them with San Diego lenders offering competitive interest rates.