Two years ago, the easiest way for most Americans to raise fast cash was through a home equity loan. But nowadays, those same home equity products are among the hardest to qualify for, as lenders continue to tighten up on their application rules and purse strings.

Home equity loans-as their name implies-are completely dependent upon home equity as their underlying collateral. Now that home prices have crumbled, home equity loans are hard to get and will probably remain so for the next few years.

Rather than eliminate home equity products, lenders have chosen to restrict them to only their top-tier clients. They've already begun to impose severe restrictions that will screen out any customers with less than stellar credit.

The path to home equity loans

Here are three of the main obstacles borrowers can expect to face when they apply for home equity loans in 2008:

  1. Collateral Valuations: Real estate that's used as collateral to secure loans will be heavily scrutinized. Appraisals will tend to be more conservative, because nobody can predict how far home values may fall. Deterioration in the housing market has already broken historic records, but until prices hit bottom and find some traction, appraisers have to factor in the dubious nature of current values and discount valuations accordingly. That means that your home is probably worth less than you think in the eyes of lenders, so prepare for the worst.
  2. Documentation of Assets and Income: Two years ago, it was possible to walk into a bank, state your income, and walk out with a loan. These days, lenders are more wary, however, and they prefer to see solid proof of how much a borrower earns and what constitutes his net worth. The problem for consumers is that typical net worth is heavily weighted in two categories, stocks and real estate. Both have taken severe hits and are in a bear market cycle, so the net worth for most borrowers has shrunk-in many cases, as much as 50 percent or more. Also, to verify your salary, you'll generally need to show your banker two years of income tax statements, plus recent pay stubs.
  3. Credit Worthiness: Although your credit score may be the same as it was last year, it means less. Lenders have added a few new categories to their credit score charts, and what used to be good credit may now fall into the numerical range of mediocre credit. Borderline credit is now south of the border; in other words, those without stellar credit may find it much harder to qualify for a home equity loan.

People who successfully navigate the grueling obstacle course will be approved without any problem. But unfortunately, that's not the end of the story. Even first-rate customers who are granted loans can anticipate that they'll cost more up front and carry higher interest rates. And if rates climb this year, as experts predict they will, the expense to borrow against your home equity will go even higher.

Published on August 4, 2008