Did you recently discover that a renovation home equity loan is the best way to fund your renovations? That’s great! That brand new kitchen you’ve been dreaming of is a lot closer than you think. You’ll also be happy to hear that the process of obtaining one is nearly identical to applying for a typical home equity loan; meaning you’ll enjoy the benefits without any extra hurdles to get there.
If you’re unfamiliar with the typical loan qualification process, there are two main factors your lender will look at: your FICO score and your Debt-To-Income ratio. We’ll walk you through each, so you know what to expect when you apply for a renovation home equity loan.
What is your FICO score?
We know you’ve heard of a credit score before. Well, FICO is just another name for it. You can check your credit score for free on a number of sites like creditkarma.com, or ask your credit card company if they can provide one for you (Capital One, for example, are among many companies increasingly offering this to cardholders).
What’s a good FICO score?
Renovation home equity loans require a minimum FICO score of 640. Just like your mortgage, the higher your score, the lower your interest rate will be. Anything 720 and above will often get you the best rate available.
What is your Debt-To-Income ratio?
Ok, listen up because this part is really important. The lesser understood Debt-to-Income ratio (DTI) is the second key factor that lenders will use to evaluate how much additional debt you can handle and how much of a credit risk you are. Your DTI compares what you earn to what you owe as an important measure of your overall financial health. While it seems simple by name, calculating it is a little trickier.
That’s why we’ve provided a helpful calculator to determine your DTI, and unlike many other resources out there, we’re also going to help you understand how to use it.
How to calculate your DTI ratio
First, you’ll need your annual income (pre-tax).
Then, you’ll need to total all your existing debt payments.
Debts to include:
- Current Mortgage Payments (your full payment, including taxes & insurance)
- Credit Card Debts
- Student Loans
- Car Loans
- Other loans or debt obligations
Debts you don’t need to include:
- Utilities, such as water, gas, electric
- Living expenses, including grocery bills, parking
- Monthly service bills, like cell phones, cable, internet
Now, enter all the payments into the Debt-To-Income Calculator below, and adjust income field to your gross annual income. This handy tool will divide all your monthly debt payments by your monthly income to determine your DTI. That’s it! Your lender will use this information to determine how well you handle debt.
Here’s an example:
A borrower with a mortgage of $1,000, a car payment of $300, a credit card minimum of $200, a renovation home loan cost of $750, and a gross monthly income of $7,100, or (1,000 + 300 + 200 + 750) / 7,100, will have a Debt-To-Income Ratio of 31.69%.
Your DTI Ratio:
What’s a good DTI ratio to have?
The lower your DTI, the better. Lenders consider anything under 20% as low, so if you fall within this range, you’re golden! Anything above 43%, and we suggest working to lower this number before you apply for a renovation home equity loan. As a tip, since your DTI looks at monthly payments and not total debt, focus on paying off your highest monthly payments first.
There’s one more thing…
The predictability of your income is important too. Every candidate will fit into one of two categories. Are you a full-time, salaried employee who doesn’t rely heavily on big bonuses or commission? Congrats! You’re a lender’s ideal candidate. If you work for yourself, have a fluctuating schedule or are paid hourly or by commission, then you’re going to have a slightly harder time. Here’s why…
Let’s say your DTI is a solid 30%, but a majority of that monthly income is based on sales commission. In this case, your lender has no guarantee that this number won’t change from one month to the next. The consistency of your income plays a role in the qualification process, so the bank can feel more confident they’ll get paid. If you fall into this category, you should be prepared to provide more documentation and information to the bank while applying, so they’ll feel more comfortable lending to you. Our team can help you prepare for this - typically you’ll need two years of tax returns showing income at the same levels you hope to qualify with.
By understanding how to qualify for a renovation home equity loan, you’re now ready to take the next step toward your home renovation dreams. To find out everything you need to apply, take a look at our helpful checklist, or contact RenoFi to learn more about the lending options available to you.