In the home equity marketplace, even homeowners with less-than-perfect credit can qualify for a loan.

The so-called subprime borrowers can tap into their home's equity just like homeowners with perfect credit. The major difference for subprime homeowners is that the amount of the loan is usually smaller and it comes with a higher interest rate.

Paying on time
Overall, U.S. homeowners have a good track record for paying bills. Consider these statistics from the National Home Equity Mortgage Association:

• At least 65 percent of U.S. homeowners have a good, or prime, credit rating.
• Between 25 percent and 35 percent of American homeowners fall into the subprime category, which means they have been late in making payments on debts.
• In the subprime group, however, only 10 percent have a C or D rating, which is given to those with serious credit problems. That means 90 percent of homeowners in the subprime category have experienced only minor credit difficulties.
  

Lenders say there are no fixed rules in making loans to subprime borrowers. Each application is looked at individually. There are myriad circumstances that can cause someone to miss a payment on a mortgage or other loan.

"We find that a lot of people had some sort of life event, and now it's behind them," says Paul J. Levasseur, president of Amresco Residential Mortgage Corp. in Irvine, Calif., which specializes in subprime lending. The personal circumstance may be a divorce, a medical emergency or a temporary job loss.

A matter of degrees
Anything less than perfect credit falls into the subprime category, so lenders look at the degree to which a borrower is subprime, says Bob Benson, senior vice president of The Money Store, the subprime lending subsidiary of First Union Corp.

The typical subprime mortgage borrower has an annual income of $34,000, says Jeffery Zeltzer, executive director of the National Home Equity Mortgage Association. It might be, "A schoolteacher, a firefighter, a print shop owner, the average borrower who had a small problem in credit."

The association says subprime lenders look for a common-sense balance, taking into consideration credit history, sources of income, loan-to-value ratio, debt-to-income ratio and the reasons for the loan.

Levasseur of Amresco says subprime borrowers can usually obtain a loan-to-value of 70 percent to 75 percent, and sometimes an LTV as high as 85 percent if they have only minor credit blemishes. In contrast, a prime borrower can obtain a home equity loan with a 90 percent LTV, and some lenders go as high as 125 percent.

How is LTV calculated for a home equity loan? Let's take a house that has a fair market value of $150,000, with a first mortgage principal balance of $80,000. The homeowner has $70,000 equity in the house.

If the homeowner wants to borrow $40,000, the combined debt of the $80,000 mortgage principal and the home equity loan would come to $120,000. This combined debt is then compared to the home's value of $150,000, for an LTV of 80 percent.

LTV is important because, if a borrower can't make payments, the lender turns to the property to recover the amount of the loan.

Depth of debt
Lenders also consider the borrower's debt-to-income ratio, namely, the percentage of the borrower's income that goes to pay off debt obligations, such as a mortgage, car loan, student loan or credit cards. The conventional, acceptable ratio is between 33 percent and 36 percent.

Again, lenders say they look at each individual case. "Lenders try to craft the loan for the borrower, one with a monthly payment they can pay," says Zeltzer.

Benson agrees: "One size doesn't fit all." The Money Store looks at an individual's ability to pay and will approve a "50 percent debt-to-income ratio when there is sufficient disposable income remaining."

On the average, Benson says, home equity lending has a little under 40 percent debt-to-income ratio.

Looking to refinance
In today's market of low mortgage interest rates, lenders say the majority of subprime borrowers want to refinance their home's first mortgage, which usually carries a higher interest rate -- and cash out some equity.

Levasseur says Amresco's refinancing terms for subprime borrowers usually include a 30-year fixed mortgage with interest rates from 9 percent to 11 percent.

The average rate for a home equity loan, or second mortgage, for prime borrowers is 8.82 percent in the latest Bankrate.com survey. Benson says subprime borrowers at the Money Store generally face interest rates ranging from a little over 11 percent to about 13.5 percent.

There are no restrictions on what the home equity loan can be used for, but usually subprime borrowers want to consolidate debts into a single loan with an interest rate lower than the 14.5 percent commonly found on credit cards.

In these cases, the lender will work with the borrower to create a monthly payment that is both manageable and effective at reducing debt. Of course, the subprime borrower has to be careful not to go out and accumulate new debt with the now paid-off credit card.

In his experience, Levasseur says most subprime borrowers want to improve their credit rating and, therefore, make their loan payments on time.

"And, usually after 24 months, they can restore their credit," he says.

-- Posted: Feb. 17, 1999