Getting a home equity loan in an impossible market

Today, many mortgage lenders don't even bother to offer home equity loans (second mortgages). Too many holders of second liens got burned when homes lost value and the homeowners walked away, or when folks lost jobs and the first lien holder foreclosed.

Mortgage lenders that didn't go belly-up have retrenched, many offering only conforming first mortgages or jacking up the qualifications for second mortgages.

Home equity loans: The good old days

One national lender's 2007 home equity mortgage guidelines reads like some fantastic fiction today:

The minimum credit score for a $50,000 loan was 620, and with a score of 740, you could get a loan of up to $300,000 and 100 percent of your home's value. You didn't need to prove your income and could even take 80 percent home equity lines of credit against investment properties.

Needless to say, no lender is giving that kind of deal anymore. There are three main obstacles to home equity loan availability these days.

Obstacle No. 1: Evaporation of home equity

The biggest reason for the contraction in home equity financing is the contraction in home equity. A CoreLogic report released March 8, 2011, reports that nationwide, only 54 percent of homeowners with mortgages have at least 20 percent equity--the bare minimum needed to accomplish any sort of home equity borrowing.

In fact, according to the report, nearly one in four mortgage borrowers in the U.S. have negative equity.

However, the pain is not equally distributed. Five states have roughly a third or more borrowers underwater: Nevada (65 percent), Arizona (51 percent), Florida (47 percent), Michigan (36 percent), and California (32 percent).

Obstacle No. 2: Stricter program and mortgage underwriting guidelines

Even if you're among the lucky 54 percent with the bare minimum home equity for a second mortgage, that might not be enough. Home equity lenders don't lend up to 100 percent of your home's value the way they used to. Many large banks top out at 70 percent.

In addition, a search of mortgage lenders' underwriting guidelines turns up a slew of requirements that did not exist four years ago. For example:

• Contingent liabilities are now being taken into account (liabilities you're not obligated to pay now but might be later, such as loans on which you are a co-signer). Underwriters today may add those potential payments in when determining your debt-to-income ratios, because so many co-signers today are being forced to make payments that primary borrowers have stopped making.
• Minimum credit scores have been ratcheted up from 620 to 660, to 720 to 760.
• Home equity lenders are demanding more evidence of job stability. Requirements for salaried employees to have a couple of years' tenure with their current employer are popping up. In the past, you only had to have been in the same profession for two years.

Obstacle No. 3: It's the economy

Credit histories in America have declined as unemployment takes its toll.

Even those borrowers who may have found new jobs may not have been at those jobs long enough to qualify.

Maximizing your chances for a home equity loan

Despite the grim outlook, there are willing and able home equity lenders out there.

Home equity loans are not the standard products of Fannie Mae, Freddie Mac and the FHA, so mortgage guidelines vary widely. Here are some tips to increase your chances of getting a home equity loan:

• Play the numbers. Contact many lenders to check their requirements as well as their home equity loan rates.
• Think small. Credit unions and smaller local banks are often willing to lend at higher loan-to-value ratios than large, national lenders.

Oftentimes, another mortgage product may accomplish what a home equity loan would:

• Consider FHA cash-out refinancing. The FHA allows you to pay off your current mortgage and take additional cash out, up to 85 percent of your home's value.
• Build in renovations. If you need cash for home improvements and have little or no equity, try FHA Title 1 or 203(k) rehab loans. The right sort of improvements may even increase your home's equity.
• Look into a reverse mortgage. If you're over 62, consider a reverse mortgage which comes with no credit or income standards.

Mortgage lending is a cyclical business. As the economy recovers, mortgage lenders will likely loosen up on requirements and make it easier to access the equity in your home.