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Bar now higher for tapping into home equity

Breaking into the home equity nest egg is becoming a very real possibility for more Americans as home prices rise.

But raiding the house bank is not as easy as it was before the recession, and not everyone meets the requirements to borrow from home equity.

Consumers must have a trifecta of enough equity, a high credit score and a healthy relationship between their debt and income to take money out of their house via a cash-out refinance, home equity loan or home equity line of credit, also called a HELOC.

Let’s start by defining a few terms.

HOME EQUITY LOAN: A second mortgage for a fixed amount, at a fixed interest rate, to be repaid over a set period.

HOME EQUITY LINE OF CREDIT (HELOC): A second mortgage with a revolving balance, like a credit card, with an interest rate that varies with the prime rate. Pronounced HE-lock.

CASH-OUT REFINANCE: A mortgage refinance for more than the amount owed. The borrower takes the difference in cash. Also called a cash-out refi.

“The standards were already fairly tight, but now with a lower volume of refis being done, you have more people looking at every file,” says Paul Anastos, president of Mortgage Master Inc. “There’s more scrutiny from banks and the agencies.”

YOU CAN EXTRACT EQUITY IN MULTIPLE WAYS: Some banks remain hesitant to offer equity lines of credit to homeowners. Lenders also must follow stricter mortgage rules that went into effect this year about a consumer’s ability to repay the debt.

Some lenders offer HELOCs as well as home equity loans and cash-out refinances.

“I have only one lender, U.S. Bank, that does HELOCs, but they must have the first mortgage,” says John Stearns, a senior mortgage banker with American Fidelity Mortgage in Milwaukee. “As for cash-out refis, I do those every once in awhile and am doing one now.”

Stearns said the borrower is taking out $50,000 in home equity. After the loan closes, the borrower will still have a 40 percent stake in the property. That translates to a healthy 60 percent loan-to-value ratio, or LTV – a figure that reflects how much debt remains on the property. The lower the ratio, the better.

YOU NEED LOTS OF EQUITY TO BORROW FROM IT: Home prices rose year over year for the 22nd straight month in March, according to the S&P/Case-Shiller index of home prices. That run helped 4 million mortgaged properties regain equity in 2013 and boosted Americans’ overall stakes in their homes to over 50 percent for the first time in six years.

Still, lenders require a hefty amount of equity before homeowners can borrow against their home. In general, a homeowner cashing out into a fixed-rate mortgage must have at least 15 percent equity left over, or a loan-to-value ratio of 85 percent, according to rules spelled out by Fannie Mae and Freddie Mac, which guarantee the majority of U.S. home loans.

If the homeowner chooses an adjustable-rate mortgage when cashing out, then the maximum LTV is 75 percent.

LENDERS SCRUTINIZE TOTAL DEBT PAYMENTS: LTV is not the only key percentage to tap home equity. The ratio between a consumer’s total debt and income is also part of the qualification equation. And again, the lower the percentage, the better. The magic number, according to Fannie Mae and Freddie Mac, is 45 percent.

Lenders will add up the total monthly payment for the house, which includes principal, interest, taxes, homeowners insurance, direct liens and home association dues along with any other outstanding debt that is a legal liability.

That total debt is divided by a borrower’s gross monthly income, which is comprised of base salary, commissions, bonuses and any other income such as rental income or on-time, up-to-date spousal support.

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