5 common problems with home equity loans

There was a time when obtaining home equity loans was almost as easy as purchasing a vehicle. Today, wary banks have practically locked down those funds, preventing many homeowners from getting the cash they need to make serious home improvements or repairs. In fact, in 2013 home equity lending was estimated at $60 billion - a far cry from the $430 billion that was flowing to homeowners in 2006.

If you have applied for a home equity loan but been denied, not all is lost. There are some steps you can take to help ensure that the next time around, you do qualify for the money you need. Here are the most common loan problems, and what you can do to turn things around.

You've filed for bankruptcy

The Great Recession hit everyone hard, and some wound up way over their heads, with bankruptcy their only feasible option. If you filed bankruptcy and now you are trying to get back on your feet, you just might find that the banks have tightened up every avenue to get any kind of credit, including a home equity loan.

• The solution: Make sure your credit is as good as possible. If the bankruptcy is the only dark spot on your record, banks might be more lenient when it comes to credit. Do be prepared, however, to be hit with higher interest rates.

You don't have enough equity yet

How much equity do you really have in your home? Most lenders want you to have at least an 80% loan-to-value ratio in place after you receive the home equity loan. That means you must have at least 20% equity in your home before beginning the process to qualify. But remember, this amount of equity might not get you the amount of loan you really need or want.

• The solution: Be very aware of how much equity you have, and build it up as much as possible. Making more payments toward the principal will help achieve this sooner. Remember that some banks have a minimum floor for lending on home equity; $10,000 is usually the smallest amount you can get.

You have too much debt

What if you have plenty of equity, but you also have credit card bills, a few car payments, and other loans that take a chunk of your income each month? Having too many outstanding lines of credit might mean a big "no" to any home equity loan. You want to have a very low debt-to-income ratio before you apply.

• The solution: Throw all your extra cash toward paying down the outstanding balances on credit cards, paying off the car loans, and otherwise cleaning up what you owe. Keep your high-limit cards but slash away at the balances. You want to show that you have plenty of credit but not much owed.

Your credit score is too low

Back in the wild days of lending, almost anyone could get serious financing - and look how all that turned out. Today, banks are very cautious and want to offer cash only to those with the best backgrounds and credit scores. In fact, many banks require a credit score of at least 620 to get a loan at all, and a score of at least 740 to get the best deal.

• The solution: Start with a copy of your credit report, and carefully evaluate every entry. Clean up anything that seems incorrect by contacting each credit bureau. Then work on building an excellent payment history and an impressive debt-to-income ratio.

You are pursuing the wrong type of loan

How much money do you need - and when do you need it? If you are planning a large purchase, like a new roof or a new addition, a home equity loan might be a good idea. But many lenders are now pushing a home equity line of credit, or HELOC, instead. A home equity loan is usually for a larger amount, while the HELOC allows you to draw out smaller amounts as you see fit. Applying for the wrong one might not get you the money you need.

• The solution: Be sure of exactly what you need from the bank. Go into the meeting with estimates, a firm timeline, and a very good idea of how much you need and when you can pay it back. The bank can help you decide which type of loan will be right for you.

Finally, keep in mind that home equity loans or lines of credit come along with many fees and closing costs. Don't forget to factor those in when figuring out the bottom line of how much you need and how much you can realistically borrow.

Photo credit to Myryah Shea