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Credit & Debt

Home Equity Taps Out

New lending rules make it harder to borrow against your home.

When bankers use such catchphrases as "liquidity crisis" and "tightened lending standards," what they really mean is that it's tougher to get a loan. That's certainly true for home-equity lending. Until recently, borrowing against soaring home values was almost as easy as getting a new credit card. Now, prospective borrowers find it more difficult to meet lenders' increasingly stringent requirements.

In some cases, borrowers simply don't own as much house as they thought they did. Home prices shed a record 4.5% in the third quarter of 2007 compared with the previous year, and no one knows how much further they'll slide. So appraisers are erring on the side of caution.

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Automated appraisals are becoming a thing of the past, says Keith Gumbinger, of HSH Associates, which surveys mortgage lenders. You'll likely be required to get a walk-through appraisal, which typically costs between $200 and $400.

In states such as Nevada and Arizona, which have been hit hardest by falling prices, loan underwriters are knocking an extra 5% to 10% off a home's appraisal when determining available equity, says Ted Rachuna, a mortgage broker in Reno, Nev. Appraisals are based on past values, which may not reflect future prices in a declining market, Rachuna explains.

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Even if you get a loan, you may not be able to borrow as much as you'd like. The loan-to-value ratio -- the percentage of your home's value against which a lender is willing to lend money -- used to stretch to 100% and sometimes more. But the ratio, which also factors in the outstanding amount of your first mortgage, rarely exceeds 90% these days.

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Bad credit? Forget it. For financial institutions, having subprime loans on the books is akin to a diagnosis of bird flu. The worse a borrower's credit, the slimmer the pickings, and options all but disappear for credit scores of less than 680. The good news is that underwriting processes are becoming more hands-on, so lenders are more likely to consider your whole financial picture rather than just your income and credit score.

If you clear the lender's hurdles, you could benefit from receding interest rates as the Fed battles a sluggish economy. The current average rate on a variable-rate home-equity line of credit (HELOC) is 7.74%, according to HSH. On a fixed-rate home-equity loan, the average rate is 8.07%. And interest on home-equity loans and HELOCs of up to $100,000 is generally tax-deductible no matter how you use the money.

Most HELOC lenders will still assume closing costs, including those appraisal fees. But if you close your line of credit within the early-termination period, you'll have to pay the fees back. For a home-equity loan, closing costs are typically the borrower's responsibility.

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The refi option. A cash-out refinancing is one alternative to a home-equity loan. Or you could consolidate an existing loan or line of credit into a new first mortgage. The average rate for a fixed-rate, 30-year mortgage has dropped below 6%. You'll need to factor closing costs into the total tab, plus private mortgage insurance if you refinance into a loan that's more than 80% of your home's value. The deal may not look too good if refinancing throws your mortgage into jumbo territory of $417,000 or more; that could add as much as a full percentage point to your interest rate.

The market is a jungle. Says Gumbinger: "You can find pricing disparities of two percentage points or more for loans with similar terms." So it's more important than ever to shop around. A large bank -- particularly the one that granted your first mortgage -- or a credit union will likely offer the most favorable terms.

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