Financial Literacy 2007 - Home equity
A cartoon woman on a ladder putting a large coin into the roof of a yellow and blue house with and blue and yellow background
home equity
Hurdles facing home equity borrowers

Home equity lending standards are tightening due to a rash of defaults and the move by some subprime lenders to file bankruptcy or go out of business. The industry has taken a hit and less credit will be available for at least six months while lenders see what the market does.

Changes coming for borrowers
  1. Fewer no-doc loans.
  2. Fewer piggyback loans.
  3. Tougher requirements.
  4. Good news on rates.
These unexpected jumps in default rates will translate to tougher underwriting standards, says Katie Porter, associate professor of law at the University of Iowa and a mortgage bankruptcy researcher. If you're ready to borrow against the equity in your home, expect to provide more documentation and don't expect to borrow your home's full market value, says Porter.

1. Fewer no-doc loans

Borrowers can expect a decline in "no documentation" loans -- also called no doc, low doc or liars loans. These loans require no verification of the borrower's income strength. Lending decisions are based purely on asset value and the lender will foreclose if the borrower can't pay. The default rate on these loans is much higher. And, because the real estate market has slowed in many areas, the risk to both the borrower and lender has increased. Porter allows that this type of loan may still be appropriate in certain circumstances for consumers with nontraditional income sources, whose income is hard to prove, but there.

2. Fewer piggyback loans

The other trend she sees is a cutback on piggyback loans because of their high default rates. A 2006 Standard & Poor's study found that piggyback loans are 43 percent more likely to go into default than stand-alone first mortgages of comparable size. That number rose to 50 percent for borrowers with FICO credit scores of 660 or less -- a score that still falls in the "acceptable" range. Instead, Porter predicts a return to private mortgage insurance and larger down payment requirements. "We'll see piggyback loans not carrying such a high load of debt-to-equity ratio," she says.

3. Lenders tightening requirements

Even though many of the loans going into default were granted based on well-proved credit scores, some types of loans offered hadn't been around in the past. In addition, lenders had been loaning on higher percentages than ever before, with some legitimate lenders offering loans up to 100 percent of home value, and some predatory lenders offering up to 125 percent. Loans will definitely require more investigation than has been the case during the past two or three years.

4. Good news on rates

One bright spot is that interest rates are not expected to rise dramatically in 2007, based on initial conclusions from Freddie Mac.

Freddie Mac's January 2007 Economic Outlook says inflationary pressures are expected to remain low due to falling energy prices: "Low inflation is likely to keep long-term interest rates below 6.5 percent this year and the yield curve -- i.e., the difference between short and long-term rates -- is likely to remain inverted throughout the coming year. One-year Treasury ARMS are forecast to average 5.5 percent each quarter of 2007." Of course this all comes with the caveat: "Energy price shocks could impact this prediction."

Audio story: What home equity lenders look for

Has home equity funded your dreams or turned into a nightmare? Share your story.

« Back to the Table of Contents

advertisement

Show Bankrate's community sharing policy
          Connect with us
advertisement
MORTGAGE & REAL ESTATE NEWSLETTER

Timely market news and advice for consumers ready to buy, sell or invest in real estate. Delivered weekly.

advertisement

Ask Dr. Don

Use home loan for college costs?

Dear Dr. Don, We have owned our home for five years. It's currently valued at $325,000. We'd like to borrow $50,000 to $70,000 for college costs. Can we take out a second mortgage at a lower interest rate, or must we take... Read more

Partner Center
advertisement

Connect with us