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It's possible to qualify for a home equity loan if you have high credit card debt, but if you do qualify, you might not get the best available interest rate and fees on the loan. That's because heavy credit card debt can diminish your perceived creditworthiness by elevating your debt-to-income ratio (DTI) and lowering your credit scores. Here's a rundown on what you should know.
How Does a Home Equity Loan Work?
A home equity loan allows you to borrow roughly 75% to 85% of the equity you have in your house—the percentage of the house you own outright, or the difference between the house's market value and the amount you still owe on your original mortgage.
If your house is worth $420,000 and you owe $230,000 on your mortgage, your equity is $190,000 or 29%—so you may be able to borrow as much as $140,000 to $160,000 against it. If your original mortgage is paid in full, you have 100% home equity and can borrow against its full market value.
A home equity loan is a type of second mortgage, which means it uses your house as collateral. That also means if you fail to repay the loan, the lender can foreclose on the house.
When you apply for a home equity loan, much as when you apply for a primary mortgage, the lender will scrutinize both you and your house. They'll want to confirm the value of the house via a home appraisal, to determine your equity stake, which in turn determines the maximum amount you can borrow. They'll also evaluate you for creditworthiness—your ability to repay the loan and your track record of debt management. That's where credit card debt could have an effect on your loan approval.
Is Credit Card Debt a Factor With Home Equity Loans?
Yes, high credit card debt can hinder your ability to qualify for a home equity loan. And if you do qualify for a loan, it can mean significant additional interest costs. High credit card debt can influence your home equity loan application in the following ways:
Increased Debt-to-Income Ratio
High credit card balances generally mean high minimum payment requirements on your credit cards, and that inflates your debt-to-income ratio—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 ratio by dividing your gross monthly pay 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 include a $2,200 payment on your primary mortgage, a $400 car payment and three credit cards with minimum required payments of $100, $200 and $250, here's how to calculate your DTI:
- Add up your monthly debts.
$2,200 + $400 + $100 + $200 + $250 = $3,150
- Divide your monthly debt total by your monthly gross income.
$3,150 / $7,200 = 0.438
- Multiply the result by 100 to get a percentage.
0.438 x 100 = 44%
If you pay down the two cards with the highest balances so that their minimum monthly payments are reduced to $100 each, your DTI ratio would change to $2,900/$7,200, or 40%. That could make the difference between qualifying for a home equity loan and having your application declined.
Reduced Credit Scores
Large amounts of credit card debt typically mean you're using a large portion of your cards' credit limits, and that can lower your credit scores. Your credit utilization rate—the balance on a credit card or other revolving account expressed as a percentage of its borrowing limit—is a significant influence on credit scores, and utilization rates that exceed about 30% tend to lower your credit scores.
Most home equity lenders require a FICO® Score☉ of at least 680, and some look for scores of 720 or better. If you narrowly meet these minimum requirements, you may get a loan but, thanks to the practice of risk-based pricing, you'll likely be charged a premium interest rate. Lenders reserve their best rates for borrowers with high credit scores, so if high utilization weighs down your scores, it could mean significant interest costs over the life of the loan.
How to Reduce Credit Card Debt Before Applying for a Loan
If you're carrying a lot of credit card debt and want to improve your chances of getting a home equity loan with good borrowing terms, these tactics for paying off credit card debt could help:
- Borrow from friends or family. Using a short-term loan from family or friends to pay down high credit card debts could help you qualify for a home equity loan with a favorable interest rate. Just be sure to set up repayment terms before borrowing to protect your relationship.
- Redirect discretionary spending. You may be surprised how much extra money you can put toward paying down credit card debt if you reduce your everyday spending for a while. Look for opportunities to lower your utility bills and insurance premiums and consider cutting back (if not altogether eliminating) unnecessary extras until you've brought down your debt. Going without extra streaming subscriptions, daily lattes or other frills might sting, but making that temporary sacrifice to get your card debt under control could be well worth it.
- Increase your income. Consider a part-time job or other side hustle as a means of generating extra income you can put toward paying down your credit card debt. The additional earnings could help with your DTI calculations as well.
- Seek a debt consolidation loan. Taking out a new loan to qualify for a home equity loan is a questionable strategy, but under the right circumstances it could help: Using a personal loan for debt consolidation to pay off a sizable chunk of your credit card debt could ease the effects of balances mushrooming with compound interest charges and make it easier to catch up using other tactics listed above. Just remember that payments on your personal loan will factor into your DTI ratio and plan accordingly.
The Bottom Line
High credit card debt might not prevent you from getting a home equity loan, but its impact on your DTI and credit scores could lead to paying more in interest than you'd otherwise be charged on the loan.
Whenever you're shopping for a loan of any kind, checking your FICO® Score from Experian can help you understand how lenders will view your application. Checking your credit report and reviewing factors that may be decreasing your credit score—then working to improve your credit score before applying—could mean a big savings in interest charges and fees.