Until the recent great recession, a home equity loan was a reliable way for homeowners to access the cash potential of their home. A homeowner with good credit and available home equity could take out a second mortgage or a home equity line of credit, use the money to pay for a major household expense, and then pay back the money over time.All loans involve risk, but the risk generally centered around the borrower’s job prospects or personal health. With real estate values constantly rising, until 2008 few borrowers or lenders would have imagined that a significant risk to the home equity loan market would be declining home values. But home equity loans depend upon stable or rising home values. What do you do when the value of your home is falling? Should you consider a home equity loan in the current poor real estate market?Declining Home ValuesAccording to a recent survey by Reuters/University of Michigan, a record number of U.S. homeowners believe their homes have depreciated in value. For the month of February 2009, 64% of surveyed homeowners reported declines in the value of their homes. In contrast, the February 2008 survey reported that 35% of homeowners surveyed thought their homes had lost value. In February 2007 the figure was just three percent.Did anyone’s house increase in value? In February of 2009 only nine percent believed the value of their home had increased, which is the lowest recorded number in nearly two decades.There has been a corresponding drop in the number of new mortgage loans including refinancing loans. According to the Mortgage Bankers Association weekly index of mortgage applications, during the last week of June 2009, U.S. mortgage applications dropped to a seven-month low. The number of home refinancing loans fell 30 percent.A Case Study of a Home Equity LoanWhat does this mean in reality? Let’s say you bought your house in 2001 for $300,000. You put $50,000 down and took out a 30-year, 7% fixed-rate mortgage for $250,000.After paying your mortgage for eight years, in 2009 your loan balance is $222,000. If your home were appraised at its 2001 value of $300,000, the equity you now have in your home would be the appraised value minus the principal or loan balance, or $78,000.That’s the part that you “own.” It’s what you can use as collateral for a home equity loan-either a second mortgage or a home equity line of credit. But how much could you borrow? The key is the loan-to-value ratio (LTV). Before the current recession, some homeowners could get a loan for 125% of their home’s value. That is, if they owned their home outright and the home was appraised at $250,000, they could borrow up to $312,500 against it. But the industry has tightened up, and today the limit is 100%, and more often 80% of value. Some FHA loans offer cash up to 95%.The LTV that your bank is willing to offer you will depend upon not only your home’s value, but your credit rating and your income.Let’s return to your home that you bought in 2001 for $300,000. At the traditional rate of increase, by 2009 your home might have appreciated to $375,000 from its 2001 value of $300,000. Instead of $78,000 in equity, you would now have $153,000 in equity-nearly double the amount! It’s no wonder that until 2008 homeowners were flocking to banks for home equity loans.But in today’s real estate market, the sad fact is that your $300,000 home may now be only worth $200,000. This is less than what you owe to the bank! There’s no way you’re going to get a home equity loan because technically you have no equity. You have two choices: sell short and take a loss on your house, or sit tight and wait for property values to rise again, as they surely will.
