Home equity loans and debt consolidationIn the past, when home equity loans were easier to qualify for, many homeowners used them to pay off credit card debt since the interest rates on home equity loans are much lower. McClintic says the interest may also be tax deductible. "Borrowers have to specify to the lender that they want to consolidate their debt as part of the home equity loan transaction so that the debts are paid and to avoid having the credit card payments considered as part of their debt-to-income ratio." However, since debt-to-income ratios and credit score guidelines have tightened in recent years, not all borrowers will be able to qualify for a home equity loan to pay off their debt. "In the past, some borrowers used a home equity loan to consolidate debt and then charged their credit cards to the maximum limit again," says Blackwell. "If a borrower has a long track record of carrying high levels of credit card debt, the credit card payments may still be included in the debt-to-income ratio when qualifying for the home equity loan. We need to make sure they can handle all the payments if they run up their debt again."
Furthermore, the foreclosure crisis has made consumers more aware of the dangers of adding to their mortgage debt. Many decided for themselves to explore other options to reduce their debt level.
Home equity loan qualificationsBlackwell says that borrowers should expect their home equity loan application to be similar to a first mortgage application in terms of documentation and proof of the ability to repay the loan. "Five years ago you may have only had to supply a pay stub, but today lenders must verify everything for a home equity loan," says Blackwell. "The process typically takes 30 to 45 days compared to a week or two a few years ago." Unlike a few years ago when homeowners could borrow up to 100 percent of their home value, lenders today usually loan a maximum loan-to-value on both the first and second mortgages of 80 to 85 percent, says McClintic. "The amount homeowners can borrow varies according to the housing market, so in distressed housing markets the maximum loan-to-value could be lower than 80 percent," he says. In addition to sufficient home equity, homeowners will need a good credit score and an acceptable debt-to-income ratio. Blackwell says 700 to 720 is often the lowest acceptable credit score for a home equity loan. "Someone with a lower credit score might be approved if they have plenty of income and home equity and a reason for a lower score such as an explainable event rather than multiple financial issues," says Blackwell. The maximum debt-to-income ratio can go as high as 45 percent, but often this will be lower depending on the borrower's history and the lender's standards.
Home equity loan costsInterest rates are slightly higher for a home equity loan than a first mortgage, says Blackwell. "Closing costs are usually built into the loan for a home equity loan," he adds.
While you may be inclined to approach your current mortgage lender for a home equity loan, you should shop around, says Blackwell. Shopping around for a home equity loan allows you to compare interest rates and closing costs.