HOME equity lines of credit, sometimes known as Helocs, have been a popular financial tool for homeowners precisely for times like now, when it helps to have a monetary cushion in case of job loss or some other unforeseen fiscal glitch.
These lines of credit essentially replaced savings accounts as the fallback, with many financial advisers counseling homeowners to keep a $50,000 line open at all times.
But that fallback is evaporating. Lenders in the past year have made it much more difficult to qualify for home equity lines of credit, and even those who do get them will pay a much steeper price in interest — about 5 percent, in fact, which is higher than the average long-term mortgage.
During the real estate boom years, home equity lines of credit commonly carried interest rates that varied in accordance with the so-called prime rate. Those with good financial histories could expect their interest rates to float about one half of a percentage point below the prime rate.
Roughly a year ago, though, banks changed the terms of these loans — along with nearly every loan in which borrowers took equity out of their homes. As the economy and housing market declined, it made little sense for banks to lend money on an asset that was becoming less valuable by the week, and in an environment where borrowers had a diminishing ability to repay.
The first sign of a hiccup for home equity credit lines came in the middle of last year, when many banks began canceling unused portions of homeowners’ lines of credit. Such measures presaged interest-rate increases. Since July 2008, the average interest rate paid on a home equity line of credit has been rising, even as the prime interest rate has fallen. The prime rate now holds steady at 3.25 percent.
In New York last week, the average rate for a home equity line of credit was 5.38 percent, according to Bloomberg News. In Connecticut it was 5.07 percent, and in New Jersey, 4.74 percent.
Why the disparity? According to Cameron Findlay, the chief economist at LendingTree, an online mortgage lender and broker, New Jersey’s borrowers have defaulted on credit lines at a lower rate than in many other states, and property values are dropping less sharply. So New Jersey’s residents enjoy better interest rates. (And, no, if you live in New York you cannot jump across the border and get better rates from a New Jersey lender.)
This is not to say that it is any easier to get a home equity line of credit in one state than another. Mr. Findlay says borrowers with credit scores of at least 720, and a stable income that they can document, are good candidates for these loans if they have more than 20 percent equity in their homes.
For a buyer to qualify for a traditional first mortgage, its monthly payment — including interest, taxes, insurance and any association fees — must not exceed 31 percent of his or her gross monthly income.
Banks will also examine the borrower’s combined debt-to-income ratio, which includes monthly debt payments like credit cards and auto loans. If, along with the first mortgage, a person’s combined monthly debt exceeds 38 percent of their monthly income, banks will not offer a loan, according to Mr. Findlay.
On home equity credit lines, he said, banks will more closely scrutinize the combined debt-to-income ratio — for instance, looking further into the borrower’s past credit card bills to determine whether he or she tends to spend freely.
Mr. Findlay said that another reason for the increasing expense of home equity credit lines was the diminishing number of banks offering these loans and the resulting lack of competition.
Banks that are struggling to reach profitability, he said, have had to allocate their money carefully, choosing the loan products with the biggest profit potential. In the current market, that is 30-year fixed-rate mortgages.
Those homeowners who borrowed against their equity credit lines during the boom, meanwhile, should be thankful for the sub-3 percent rates they now enjoy.
Meanwhile, Mr. Findlay says that if the bank has not cut your equity line, you can start to breathe more easily.
“If they were going to cut yours,” he said, “they probably would have already done it by now.”