Second mortgage rates are dropping, but lenders are tightening up the qualification requirements for home equity loans and lines of credit.

In professional basketball, there are high percentage shots (dunks), and last-second, circus attempts thrown up to beat the clock. The climate of today's environment for second mortgages is somewhere in between, something like the 15-foot uncontested jumper. While mortgage rate trends are positive, underwriting trends are putting a hand in the face of second mortgage applicants.

Rates heading down

Since the beginning of the year, the prime rate has dropped 1.25 percentage points. This should be big news for borrowers, because the prime rate drives the pricing on many consumer loan products, including second mortgages. The decline translates to a $20 monthly savings in interest costs for every $20,000 of outstanding debt.

Loan requirements heading up

Unfortunately, the good news on rates is tempered by an increasingly conservative underwriting environment. In years past, second mortgage approvals were handed out to almost anyone, as long as the home's value was properly documented. That isn't the case any longer. Lenders are now scrutinizing borrower qualifications, demanding higher FICO scores, more home equity, and full income documentation. These new, more stringent requirements are trumping the rate decreases by making it impossible for some homeowners to qualify for a second mortgage.

A look at FICO score thresholds demonstrates how things have changed. Not long ago, a borrower with a 630 FICO score could obtain a second mortgage without too much trouble. Today, lenders prefer to see FICOs closer to 700. To put this in perspective, 27 percent of the U.S. population has a FICO score that falls between 600 and 699. A good number of these borrowers will face more difficulty getting a second mortgage than they would have just two years ago.

High loan-to-value second mortgages are a thing of the past too. Loan-to-value is the amount of total mortgage debt outstanding, relative to the home's market value. If a borrower has first and second mortgage debt totaling $200,000 on a home worth $250,000, the combined loan-to-value is 80 percent. In the heyday of mortgage lending, resourceful borrowers could actually borrow up to 125 percent of their home's value. Now, many borrowers will have access to only 70 or 75 percent.

Stated income loans have also virtually disappeared. Self-employed homeowners and others who can't provide complete income documentation may be forced to go without that second mortgage.

No second mortgage benefits for homeowners

Even though rates have gone down, fewer homeowners will realize the benefits. Those interested in a low-priced second mortgage should be prepared to show lenders a strong credit score, ample home equity, and stable income history. Without these qualifications, the loan approval will be less-than-certain. Realistically, it may be necessary to pull the ball out and wait for a better look at the basket.

Published on March 4, 2008