“As a country, we’re equity rich, but the tightened credit box has locked many people out of the ability to access that equity,” says Nicole Rueth, producing branch manager for Fairway Independent Mortgage Corp. in Denver.
Collectively, Americans had $6.2 trillion in “tappable equity” during the fourth quarter of 2019, which refers to the amount available to borrow before hitting a maximum of 80 percent of the home’s value, according to Black Knight, a mortgage data provider. The average amount of available equity was $119,000 during that quarter. Many lenders cap the amount homeowners can borrow with a first mortgage and any additional loan at 80 percent of the home’s value.
But having home equity isn’t the same as being able to convert that value into cash, especially if you have been furloughed or are unemployed. Several large banks, including JP Morgan Chase and Wells Fargo, stopped accepting applications for home equity loans and home equity lines of credit earlier this spring.
“Banks are thrilled to lend you money when you don’t need it, but not when you do,” says Brian Sacks, branch manager with Homebridge Financial Services in Pikesville, Md.
Still, many financial institutions offer refinancing options and some continue to offer home equity loans to consumers who are currently employed. But borrowers should anticipate tighter standards for qualifying for a new loan such as higher FICO credit score requirements, particularly if they plan to tap into their equity.
“Lenders are nervous right now and rightly so because of these high levels of unemployment,” says Shawn Low, co-founder and head of operations for Better.com mortgage in New York City. “Also, an inadvertent impact of the mandate to offer forbearance to borrowers for up to 12 months is that it exacerbates lender’s tendency to be risk-averse. They have to cover those mortgage payments while in forbearance, so they have less cash to loan and don’t want to risk getting stuck with another loan that might go into forbearance in the future.”
Forbearance refers to borrowers pausing their mortgage payments partially or fully because of an emergency such as the novel coronavirus and the economic downturn.
While Low says his company continues to offer cash-out refinancing, which allows borrowers to increase their loan balance and take out some of the equity in their home, the minimum FICO score required for those borrowers was raised to 680 from 640. Homeowners who refinance without taking out cash and increasing their loan balance need a minimum FICO score of 620 at Better.com.
Regardless of their credit score, borrowers who are furloughed can’t qualify for any loan because they don’t have income to prove that they have the ability to repay it, says Sacks.
“Their only option is if a co-borrower is working and has enough income to qualify for the payments or if they can find a co-signer for the loan,” says Sacks.
While your ability to qualify for a loan once you are back to work depends on your income and credit score, it also depends on loan requirements about employment.
“FHA loan rules say that if you have been out of work for six months, you must be employed again for six months before you can qualify for a loan,” says Rueth. “Conventional loans allow you to potentially qualify as soon as you go back to work.”
For those who are working and have equity in their home, a cash-out refinance may be more readily available to access that equity than a home equity loan or home equity line of credit (HELOC).
“I’m getting more requests than usual for cash-out refinancing in part because people want to renovate their homes and think this may be a good time to get a deal with a contractor,” says Heather Devoto, vice president and branch manager for First Home Mortgage in McLean, Va. “I’m also getting calls from homeowners with a lot of equity who want to refinance into a new 30-year mortgage at a lower rate so they can lower their payments. That makes the loan more manageable in case one of the borrowers loses their job.”
Devoto says that a FICO score of 740 is required to get the lowest rates on a refinance. Borrowers who need to refinance a jumbo loan, which is an amount above the conventional loan limit of $765,600, will need a FICO score of 800 to get the lowest rates, she says.
While lenders before the 2008-2009 housing crisis allowed borrowers to take out loans for 100 percent of their loan value and sometimes higher, most cash-out refinancing in recent years has been limited to a total mortgage balance of 80 percent of your home’s value. For example, if your home is worth $500,000, you can borrow up to $400,000. If your current mortgage balance is $300,000, you may qualify for a cash-out refinance and take up to $100,000 in cash.
Some lenders currently are reducing their risk and further limiting the amount they will lend for cash-out refinancing or have eliminated cash-out refinancing completely.
“Every lender has their own standard for protecting themselves,” says Rueth. “We’ve pulled back a little and will only allow borrowers to go up to 75 percent of their home’s value.”
Fairway’s minimum FICO credit score for cash-out refinancing is now 720, while a traditional refinance borrower needs a FICO score of 680 and a purchaser needs a 640 score. However, Rueth says, these requirements are often adjusted.
“It’s important for borrowers to shop for a loan because lenders vary on their requirements,” says Low. “They should also look at all their options for refinancing or borrowing their equity in the context of their goals. If you need cash for a few months, a cash-out refinance could make sense, but you need to realize that increasing your balance could make your payments rise even if you lower your interest rate.”
Low points out that interest rates are lower for a first mortgage than for a home equity loan or a HELOC. In addition, the interest on the first loan is tax deductible but may or may not be for a home equity loan depending on its purpose.
If you face a short-term cash need, another option is a traditional refinance, referred to as a “rate and term” refinance because you are changing your interest rate and starting a new loan term.
“With a rate and term refinance, you pay off the balance of your current loan and roll in your closing costs,” says Sacks. “You can potentially skip one or two payments when you refinance and you can lower your payments, especially if you choose a new 30-year fixed-rate loan. That may be a better option than forbearance or taking out cash for some people.”
Borrow your equity
While Rueth says cash-out refinancing may be the best option for borrowers who currently have a high interest rate, borrowers can also compare home equity loan and HELOC options.
“A home equity loan is great in a rising interest-rate environment because you can take out the cash and lock in a fixed rate,” says Rueth. “A HELOC offers more flexibility since you don’t have to use all of it at once. In a low interest-rate environment like this, a HELOC can be a good choice because even though the rate fluctuates, rates are expected to stay low.”
The right choice also depends on how you plan to use the money.
“If you want to improve your cash flow and consolidate debt, cash-out refinancing can be a big improvement because you can lock in all your debt for 30 years at a low rate,” Rueth says. “But it all depends on your risk tolerance and your current loan terms.”
Consolidating debt can be a big mistake, says Sacks, because if you take out equity to pay off a car loan or credit card balance, you’ll continue paying those debts for 30 years, long after the car is gone. Debt consolidation can also be risky for less disciplined borrowers who may accrue additional debt after consolidation.
Many homeowners use a HELOC as a source for emergency funds. A home equity loan provides a lump sum of cash and fixed payments, but Sacks says most lenders don’t offer these loans. Home equity loans and HELOCs are riskier for lenders because they are in second position if a borrower defaults on their loan and a foreclosure occurs. There may not be enough money left after the home is sold to pay off a second loan. A HELOC is slightly less risky because lenders can close access to the line of credit immediately if payments are not being made.
A credit union can sometimes offer more flexibility for borrowing your home equity.
“We qualify borrowers on a case-by-case basis and make exceptions depending on their qualifications,” says Reed Voorhees, a mortgage loan originator at Tower Federal Credit Union in Laurel, Md. “In some cases we will allow someone to borrow up to 100 percent of their home value.”
Typically, Voorhees says, they loan up to 90 or 95 percent of the home’s value with either a HELOC or a home equity loan if they have a 680 FICO credit score and a maximum debt-to-income ratio of 45 percent. The debt-to-income ratio compares the minimum monthly payment for all recurring debt with your monthly gross income.
“We are conservative and look for strong credit quality among borrowers,” says Voorhees. “We do verbal verifications of employment the day of closing, review the most recent pay stubs and require written verification of employment as well.”
Voorhees says a HELOC can be a good safety net for homeowners, but he also recommends having cash savings in place.
A reverse mortgage offers another way to access your equity if you are older than 62, but homeowners must fully understand the loan and its consequences, says Sacks. The loan can provide a monthly payment, a lump sum or a line of credit for seniors, with the amount depending on their age and home value.
“A reverse mortgage is right for the right situation and wrong for the wrong situation,” says Sacks. “A common misconception is that the bank takes the house at the end of the loan. But when the borrowers no longer live there and there is equity left, they can sell it and keep the equity or their heirs inherit it.”
HELOC as a backup
One consequence of the housing crisis and sharp drop in home values a decade ago was that HELOCs were frozen or closed by many lenders.
“There’s no sign of that happening yet because home values have held up so far,” says Devoto. “But everything seems to change day by day and we’ll have to see how states manage as they reopen businesses.”
Ideally, homeowners should have a robust emergency savings account in their bank. Several lenders suggest that opening a HELOC is a smart move as a backup plan to allow for access to your home equity in case of an emergency.
“HELOCs are typically inexpensive to open and maintain and as long as you don’t use it you don’t have to make payments,” says Devoto. “I think buyers should take out a HELOC as soon as they can, as long as they are careful to keep it as an emergency back-up fund.”
If you’re concerned that your HELOC could be frozen and anticipate possibly needing the funds, Rueth says one idea would be to withdraw some or all of your available credit and deposit it into your savings.
“Don’t spend it unless you need it,” Rueth says. “You will have to make interest payments on the balance, but if you pay it back as soon as you resolve your financial issues, then this could be an option to consider. It’s heart-wrenching that so many people are unemployed now, but for those who are employed, it would be smart to apply for a HELOC as one more piece of financial protection in case a second wave of unemployment hits.”