It’s a simple idea: Borrow against your home to renovate, pay off credit cards, send a child to college or build up a rainy-day fund. But getting a home equity loan can be especially challenging today and lenders are worrying more than ever about getting paid back.
In the second quarter, delinquency rates were higher on home equity installment loans than in any other consumer loan category, according to the American Bankers Association. About 4.12% of home equity installment loans were at least 30 days overdue, compared to 3.88% for credit cards, 3.03% for car loans through dealers and 1.79% for car loans through banks. About 1.81% of home equity line of credit loans, or HELOCs, were also delinquent.
A HELOC is a revolving loan with a credit limit, similar to a credit card, while a home equity installment loan is typically a lump sum much like a mortgage. Both types use the home as collateral, and therefore charge lower rates than unsecured loans like credit cards. Installment loans have fixed rates, while lines of credit have floating rates that can adjust as often as every month.
Rates on installment loans currently range from 6.97% for a 36-month loan to 8.3% for a 15-year loan, according to the BankingMyWay survey. Many lines of credit start as low as 3% to 3.25%, according to the BankingMyWay search tool. Many HELOCs adjust by adding a set number of percentage points to the prime rate, which is currently 3.25%. That margin is typically around 2 percentage points for borrowers with excellent credit, so they’ll pay roughly 5.25% once the introductory rate ends, usually within a few months.
The delinquency rate on installment loans is high because many borrowers have stopped payments due to lost jobs or a feeling there’s no point paying back a loan on a home that has fallen in value. In a foreclosure, a home equity lender does not get paid until the primary mortgage lender gets all it is owed, so home equity lenders typically get nothing if the home’s price has fallen.
This has made home equity loans something of a disaster, with lenders writing off billions in unrecoverable debt. Lenders continue to offer home equity loans, but before you expend time, money and effort, it pays to evaluate your chances of qualifying.
Obviously, this means you need a good credit history and enough income to make your payments. Once you’ve found a few attractive lenders, ask them what credit score they require, then check yours.
Another key issue is loan-to-value ratio. While lenders’ rules vary, in this era of tight credit, you may find that the primary mortgage and home equity loan when taken together, cannot exceed 80% of the property’s value. In other words, if the property is worth $300,000 and your mortgage balance is $200,000, you could get a home equity loan of no more than $40,000, since $240,000 is 80% of $300,000.
Keep in mind that LTV uses the property’s current value, not the price you paid. Nationwide, about 11 million homeowners, or about one in four with a mortgage, are thought to owe more than their property is worth. Obviously, these homeowners will not qualify for home equity loans.
For an estimate of your home’s current value, go to Zillow.com. Find your property by typing in your address, then click the “Similar Sold” button for a listing of recent sales, prices and prices per square foot. You might drive by nearby properties that sold within the past year to see which are comparable to yours, then use them as a starting point to determine the average price per square foot of your property, while also double-checking the Zillow estimate.
Once you apply for a home equity loan, the lender will probably order an appraisal. Because appraisers were widely criticized for valuing properties too high a few years ago, many are now more conservative. If you have any reason to think your equity isn’t big enough to support a new loan, it may not be worth it to spend hundreds of dollars on an application and appraisal.
—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.