When the real estate market was booming, getting approved for a home equity loan or line of credit was usually a very simple process. Rising house values gave homeowners a lot of equity to borrow against and many borrowers took advantage of their increased home value. As the housing market has cooled, however, lenders have tightened the standards used when granting home equity loans. They want to be certain that borrowers don’t stretch their equity too far in case home prices fall.
The new lending standards are intended to help protect consumers from getting over their head in debt. While it’s certainly still possible to obtain a home equity loan or line of credit -- and with their low rates and tax deductibility they can be a great way to finance a home renovation or other large expenditure -- it’s helpful to understand how the standards have changed before applying for a loan.
Here are some of the areas where you may encounter new approval guidelines:
In the new real estate climate, most lenders require better-than-average credit scores before approving home equity loans. If your score is less than 700, obtaining a home equity loan may be more difficult than it was in the past and it may be wise for you to take steps to improve your credit rating before you apply.
Lenders haven’t always required formal property appraisals when they granted home equity loans. Instead, they often relied on an “automated valuation model” (AVM) to estimate the value of a home based on its size and location. In most cases today, however, you will need to obtain a traditional appraisal. (The borrower is generally responsible for the appraiser’s fee -- typically between $300 to $600.) If the new appraisal indicates that the value of your property has declined since it was last evaluated, you may end up with less equity to borrow against than you’d anticipated.
Many lenders are now less likely to approve loans with large loan-to-value ratios, or LTVs. At the height of the housing market boom, it was sometimes possible to borrow up to 125 percent of the value of your home (less what you owed on your mortgage). Today the limit is typically 80 percent. For example, if the appraised value of your home today is $300,000, 80 percent of that is $240,000. So if you owe $180,000 on your mortgage, you could borrow up to $60,000 of your home’s equity (or $240,000 minus $180,000). This reduction in LTV limit helps to protect borrowers from potentially owing more than their house is worth.
While home equity loans and lines of credit are likely to continue to provide lower interest rates than unsecured loans, some lenders have begun to add a small margin to their rates. This is to compensate for the added risk these loans carry in today’s slower housing market, where it may be more difficult for a lender to sell a home and recoup their investment in the case of a foreclosure.
If you find yourself unable to qualify for a home equity loan, ask the lender what you can do improve your chances of being approved when you reapply. Remember that tighter regulations are designed not to penalize borrowers, but to protect them from taking on more debt than they can comfortably handle.