Whether you want to make repairs to your home or need the money for other important things (e.g. college education), tapping into your home's equity is a good option. However, just because you have equity available in your home doesn't mean you will automatically be approved for a loan. Here are two reasons why a lender may deny your application and what you can do to fix the problems.
Your Combined Loan to Value is Too High
Lenders look at a number of factors to determine a person's creditworthiness, and one of those factors is the home's combined loan to value (CLTV). This is the percentage of the total amount of liabilities against the house's market value. For instance, if a home is worth $200,000 and there are already two loans taken out on the property totaling $180,000, the CLTV would be 90 percent.
Banks generally prefer the CLTV rate to be below a certain value, because it provides them some wiggle room to mitigate losses if they have to repossess the home and sell it to recoup their money. The maximum CLTV for approval varies depending on the lender, but the highest most will go is 80 percent. If the amount of your home renovation loan will push your CTLV above the bank's limit, your application may be declined.
You do have a couple of options here. The first is to ask for less money. Banks will typically tell you what their CLTV limit is, so you would need to simply recalculate the maximum amount you can borrow based on that percentage. For instance, an 80 percent CLTV on a $200,000 home is $160,000. If your current mortgage balance is $120,000, the max you could get for the home renovation loan is $40,000.
Another option is to drastically improve your credit. Banks tend to be more lenient with people who have very high credit scores. So you may get approved even if your CLTV exceeds the limit if you have exceptional credit. Thus, take a couple of months to clean up your credit report and boost your score.
Your Debt to Income Ratio is Too High
Another reason your application may be denied is because your debt-to-income (DTI) ratio is too high. This is the percentage of your income that you pay towards your debts. If you earn $5,000 per month and your debts amount to $2,000, your DTI is 40 percent, for example.
The maximum DTI banks will accept is 43 percent, because that's the limit for the Fannie Mae and Freddy Mac Qualified Loan program that banks use to resell their home loans. When calculating your DTI, you must account for the monthly payments associated with the home renovation loan. If the addition of that loan pushes your DTI beyond the limit, then you'll need to pay off some of your other bills to get below the max DTI before a lender will approve your application.
For more information about qualifying for a home renovation loan, contact a local lender.
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