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You don't hear much about home equity loans these days. In fact, it sometimes seems that lenders have turned off the tap on the once-popular second mortgages that used to fund everything from home improvements to new cars to expensive vacations and more.

But home equity loans are still around, they're just not as common. Part of that's because they're harder to come by - falling property values have left homeowners with less equity to borrow against and banks have tightened up their lending guidelines considerably. Borrowers are also being more fiscally conservative, tapping their home equity only when they need it, rather than to finance a certain lifestyle.

How much can you borrow?

If you're interested in a home equity loan or line of credit, you should realize that lenders won't let you borrow as much as they used to. Long gone are the days when a bank would let you borrow up to 100 percent of your home equity or even beyond. The highest you can go these days is 80 percent, or 70 percent if you're in an area with unstable home values or high foreclosure rates.

For example: Let's say you have a $250,000 and owe $150,000 on your mortgage. That means you have $100,000 in equity, so the most you can borrow is $80,000, or 80 percent of your equity. If you live in a state like Florida or Michigan, where home values remain shaky, you may only be able to go as high as $70,000.

What's your home worth?

Another thing to be aware of is that your home may not be worth as much as you think it is, at least in the eyes of the appraiser. When you apply for a home equity loan, your lender will order an independent appraisal, which you'll pay for (Usually $300-$700). Appraisers often tend to be conservative these days so your appraisal could come in for less than you expect.

That means your $250,000 home might appraise for only $220,000. Using the example above, that reduces your equity to only $70,000 and the maximum you can borrow to $56,000 (80 percent of $70,000).

What about credit scores?

You're also going to need good credit, particularly if you plan on using most or all of your available equity. It used to be you could get a home equity loan or line of credit with a FICO score as low as 620, but these days 660 is more likely to be the minimum a lender will accept. If you're planning to tap most or all of your equity, a score of 720 or above may be required.

Income and employment requirements

You'll also need to be within certain debt-to-income limits. Your lender will want to see that your total monthly debt payments (including the home equity loan, or the maximum payment you might have to pay if you fully tap a line of credit) add up to no more than 40 percent of your gross monthly income. Since home equity loans are typically available in terms of 5-15 years, you may be able to stretch out your payments longer if you need to stay under the limit.

Lenders are also more particular about wanting to see evidence of a stable employment history these days. If you're a salary or wage earner, you may have to be able to show that you've been with the same employer for several years, rather than just showing you've been employed full-time for the past two, which used to suffice.

Home equity loan or line of credit?

Now for a few basics on home equity loans themselves. You can either get a home equity loan or home equity line of credit (HELOC). The home equity loan is a single lump of cash; a HELOC is a line of credit you can borrow against as needed.

A home equity loan is good for a single purpose where you know exactly how much money you'll need; a HELOC is more useful for a situation where you'll have to make ongoing expenditures over a period of time and aren't exactly sure what they'll add up to (such as a do-it-yourself remodeling project).

Both types charge interest rates that will be higher than you'll pay on a conventional mortgage. The HELOC is typically a lower rate than a straight home equity loan, but usually adjusts over time. A home equity loan is usually a fixed rate. Of course, with a HELOC you're only paying interest on what you actually borrow, though you may have to pay it back faster than you would a home equity loan.

A HELOC is good for only a certain number of years, after which the balance must be paid off or the line of credit renewed or extended, assuming your lender will do so.

Tax-exempt interest

Finally, one of the big advantages of any home equity loan is that, as a type of mortgage, the interest you pay is tax-deductable, within certain limits. That's what makes them popular choices for things like buying a car or home improvement projects.

However, you don't want to make the mistake of continually taking out new home equity loans for additional expenditures so that you never pay down your total mortgage obligations and don't rebuild your equity.That's a trap many borrowers fell into prior to the crash of the housing market and is still something to beware of, even though lending limits are much tighter these days.

Published on November 24, 2009