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Understanding Home Equity Loans and Credit Card Debt

How Does a Home Equity Loan Work?

A home equity loan allows you to borrow a portion of the equity you have in your house. Typically, you can borrow between 75% to 85% of your home equity. For example, if your house is worth $420,000 and you owe $230,000 on your mortgage, your equity is $190,000. You may be able to borrow between $140,000 to $160,000 against it.

This type of loan is a second mortgage, meaning your house is used as collateral. If you fail to repay the loan, the lender can foreclose on your house. The lender will appraise your home to determine its value and your equity stake, which influences the maximum amount you can borrow. They will also evaluate your creditworthiness, which is where credit card debt can impact your loan approval.

Is Credit Card Debt a Factor With Home Equity Loans?

Yes, high credit card debt can affect your ability to qualify for a home equity loan and the interest rate you receive. Here’s how:

Increased Debt-to-Income Ratio

High credit card balances increase your debt-to-income ratio (DTI), which is the percentage of your monthly pretax income required to pay your debts. Home equity lenders typically require DTI ratios of 43% or less. You can calculate your DTI by dividing your gross monthly income by the sum of your minimum monthly payments on loans, credit cards, and other consumer debt, then multiplying by 100 to get a percentage.

For example, if your monthly gross income is $7,200 and your monthly debts total $3,150, your DTI is 44%. Reducing your credit card debt can lower your DTI and improve your chances of qualifying for a home equity loan.

Reduced Credit Scores

High credit card debt can lower your credit scores by increasing your credit utilization rate, which is the balance on a credit card expressed as a percentage of its borrowing limit. Most home equity lenders require a FICO® Score of at least 680, with some looking for scores of 720 or better. High utilization rates can lower your credit scores, leading to higher interest rates on your loan.

How to Reduce Credit Card Debt Before Applying for a Loan

If you have high credit card debt, consider these strategies to improve your chances of getting a favorable home equity loan:

Borrow from Friends or Family

Using a short-term loan from family or friends to pay down high credit card debts can help you qualify for a home equity loan with a better interest rate. Ensure you set up repayment terms to protect your relationship.

Redirect Discretionary Spending

Reduce your everyday spending to put more money toward paying down credit card debt. Lower your utility bills, insurance premiums, and cut back on unnecessary extras until your debt is under control.

Increase Your Income

Consider a part-time job or side hustle to generate extra income for paying down your credit card debt. Additional earnings can also improve your DTI calculations.

Seek a Debt Consolidation Loan

Using a personal loan for debt consolidation can help pay off a significant portion of your credit card debt. However, remember that payments on your personal loan will factor into your DTI ratio.

The Bottom Line

High credit card debt might not prevent you from getting a home equity loan, but it can lead to higher interest rates. Checking your FICO® Score and reviewing your credit report can help you understand how lenders view your application. Improving your credit score before applying can result in significant savings on interest charges and fees.

For any mortgage service needs, contact O1ne Mortgage at 213-732-3074. We are here to help you navigate your home equity loan options and find the best solution for your financial situation.

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