When home prices were increasing, home-equity
loans were a convenient way to finance numerous types of expenditures.
While the loan is secured by the home's equity, the proceeds can
be used for anything, including expenditures that have nothing
to do with the home. In addition, home-equity loans have a significant
advantage over other forms of consumer debt - interest paid on
up to $100,000 of home-equity loan proceeds can be deducted on
your tax return if you itemize deductions. Home-equity loans typically
offer competitive interest rates, usually no more than prime rate
or 1% or 2% over prime. Competitive interest rates combined with
tax deductibility can add up to very attractive after-tax rates.
With all these advantages, it's no wonder
home-equity loans became popular with homeowners. Until recently,
lenders were often willing to offer home-equity loans on up to
100% of your home's value, with a simple application process and
a quick check of home prices in your area.
But with declining home values and increasing
numbers of foreclosures, lenders are not as anxious to approve
home-equity loans. While the loan is secured by the home, it is
a second lien that is subordinate to the mortgage. Thus, following
a sale, the home-equity loan won't be paid until the mortgage
is paid in full.
Many homeowners are being notified by lenders
that their home-equity line of credit is reduced or frozen. Most
contracts contain a provision allowing the lender to reduce or
suspend the line if home values fall significantly or the homeowner's
ability to repay the loan decreases. Signs to the lender of a
decreased ability to repay include a poor credit rating, a small
down payment with no private mortgage insurance, or late payments
noted on your credit report. If you receive such a notice but
still need the line, call and discuss your situation with your
lender.
If you are trying to obtain a home-equity
loan, be aware of these likely changes:
- The loan-to-value ratio
will probably be lower.
In the past, it was not uncommon for
a mortgage and home-equity loan to total 100% or more of the
home's market value. Now, anything over 90% is rare, and that
percentage may be much lower in markets with declining home values.
Some areas have limits as low as 65% of the home's value.
- Your credit score is
more important.
In the past, it was fairly easy to
obtain a home-equity loan. Now, lenders are more concerned with
your ability to repay the loan, using your credit rating as an
indication. If your credit score is less than 680, it will be
difficult to find a lender willing to approve the loan. The higher
your score, the more options available and typically, the lower
the interest rate you will have to pay.
- You'll need a full
appraisal of your home. In the
past, a simple review of home values in your area was often enough
for a home-equity loan. Now, you'll probably need a full appraisal,
including a walk through of your home.
