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Three Ways Foreclosures Have Hurt Home Equity Loans

[May 12, 2009.]

 

1. Foreclosure Sales Rarely Cover Home Equity Loans
In a foreclosure sale, mortgage lenders are paid off in order of lien position. Unfortunately, most home equity lenders find themselves second in line, and sometimes as far back as third in line. Given the recent decline in home prices nationwide, many home equity lenders are left with little to nothing at all after the primary mortgage is paid off. In fact, some homes have been so severely overextended that it is quite common to see even the primary mortgage lender taking a significant loss. As a result, borrowers eventually end up paying the price as these lenders try and recoup these losses.

2. Increased Defaults Cause Mortgage Lenders To Tighten Up
If the home equity lender manages to stay afloat despite the loan defaults, they will likely pass the cost to future borrowers. This translates into tightened lending, limited credit lines, and frozen credit lines for existing borrowers. In fact, since the recent mortgage downturn, many homeowners with existing home equity lines of credit (HELOC) have suffered the fate of a frozen credit line--many which have had accounts in excellent standing since origination. Unfortunately, these increasing loan defaults give lenders no choice but to limit their risk exposure to existing and potential borrowers.

3. Foreclosures Make It Difficult To Refinance
Another major consequence of foreclosures has been the negative impact it has had on a borrower's ability to refinance. As foreclosures quickly take their toll on surrounding neighborhood values, home equity prices have quickly declined nationwide. As a result, many lenders are having trouble financing borrowers with their current amount of existing debt. As an example, if a homebuyer purchased a home with 10 to 20 percent down just a few years ago, that same property might easily be financed at 100 percent or more of its current value. And as mentioned, very few lenders nowadays are willing to originate mortgages beyond such a high loan to value ratio.

Unfortunately, home equity lenders have also realized this and further complicate the problem. Since loans are structured in specific lien positions, a home equity loan is typically subordinated behind a primary mortgage during a refinance transaction. As more loans default, many home equity lenders prefer to cut their losses and be paid immediately. In short, these home equity lenders have realized the potential risks and basically want their money back as soon as they can get a hold of it.  When a home equity lender fails to subordinate their home equity loan, the homeowner now has limited choices when it comes time to refinance.

What Can You Do About it?
To overcome this, potential borrowers need to realize the position many home equity lenders are currently in. First of all, individuals should review their loan qualifications to make sure there are no mistakes or shortcomings in any category. Nowadays, home equity lenders regard "well-qualified" borrowers as individuals with a FICO credit rating of at least 720, debt to income ratios below 38%, and at least 20 to 25 percent equity. Long gone are the days of home equity lenders providing 100 percent financing to individuals with bad credit.  Now that credit is tightened, individuals need to be fully qualified to stand a chance of receiving a home equity loan.

These issues are just a quick glimpse at some of the many problems homeowners are facing with their home equity loans today. If you or someone you know is having issue with their mortgage, speak to a mortgage professional as early as you can. Using our site's directory, you can also locate a reputable home equity lender nearest you.

 

About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.

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