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Home equity loan: Why lenders are skittish

By Michele Lerner
Mortgage Credit Problems Columnist


In periods with a robust real estate market and rising values, homeowners can tap their growing home equity for a variety of needs, either by using a cash-out refinance to take out a lump sum or by taking out a home equity loan or line of credit to ease their financial burdens.

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Alas, we're not in a robust period of rising home values. In times of tightened credit and falling or stagnant home prices, lenders are more reluctant to approve a second loan on property.

The main reason lenders avoid a home equity loan is that these loans are second in the hierarchy of mortgages to be repaid if the borrower defaults. In a case of a foreclosure or a short sale -- in which the first lender agrees to accept a payoff for less than the full amount of the mortgage -- the second, home equity loan may not be repaid at all. For this reason, lenders' standards today are quite high for a home equity loan.

What a home equity lender looks for

There are two main elements to qualifying for a home equity loan:

  1. First, the home must be appraised so the lender knows there is enough value in the property to pay off both loans if the home is sold. For the nearly one out of every four homeowners who is underwater -- owing more than the value of the property -- there is no positive home equity to borrow against, so a home equity loan is not an option. However, that statistic can be flipped on its head: Three out of four homeowners do have some equity in their homes, and some own their homes outright, without any mortgage at all.
  2. If you have equity in your home, the next hurdle to clear is your credit. If you needed to work with bad credit mortgage lenders in the past, those same credit problems may mean that you'll have trouble qualifying for a home equity loan now. However, if you have worked to improve your credit and think you may be a better candidate for loan approval, complete the form on this page to find out if today's home equity lenders will qualify you.

Two ways to get home equity loan proceeds

If your goal is credit repair and to pay off large credit card balances or medical bills, a lump-sum home equity loan that allows you to pay your debts in full may be the best option.

A home equity line of credit, on the other hand, does not offer a lump-sum payment. Instead, it offers you the ability to access money when you need it. You can use, repay, and reuse the credit line. This option of receiving cash proceeds may be helpful for meeting periodic large expenditures, such as college tuition payments.

Just make sure you fully understand the loan and don't treat the proceeds as free money. With a home equity loan, your home is on the line if you default.

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