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Ready to use your home equity? Read this first

A sharp recovery in home prices over the past few years has given homeowners considerably more equity to tap, about $825 billion collectively, according to Black Knight Financial Services. This is nearly 2 1/2 times the home equity that existed just four years ago, but tapping that equity, in the form of a home equity line of credit (HELOC), is far more difficult than it was in the last decade, when a home was synonymous with an ATM.

"There is no question that HELOCs being originated today are of exceptional credit quality," said Ben Graboske, senior vice president at Black Knight Data & Analytics. "In fact, HELOC originations in Q1 2015 had the highest-weighted average credit score on record."

Home equity line lending has jumped 40 percent from just a year ago, but is still 85 percent below where it was in 2007, at the height of the housing boom. These new borrowers had an average FICO credit score of 782, which is considered extremely low risk. These borrowers are also tapping their home equity for far different reasons than they did a decade ago.

Home house suburban
David Papazian | Photographer's Choice RF | Getty Images

"People are really focused on using it for what they need, rather than for what they want," said Kelly Kockos, senior vice president of home equity at Wells Fargo Home Mortgage, the nation's largest lender. "It's less about, 'Oh, I want a trip or a boat,' but more what they need."

Borrowers also want a loan that is fully amortizing, too, according to Kockos. No interest-only payments. Wells Fargo changed its home equity line product two years ago, requiring that borrowers begin making principal payments on home equity lines immediately. This keeps them from payment shock at the end of the so-called "draw period," which is usually 10 years. Wells Fargo also has a minimum FICO requirement of 680.

"The home equity process has shifted, and it's more like getting a mortgage these days," said Kockos.

Black Knight analysts estimate that about 37 million borrowers have "tappable" home equity; that is, using a limit of 20 percent equity most lenders now require in the home, they have some equity beyond that which they could take out. More than one-third of that equity is in California alone. The vast majority of home equity is also in the top 10 metropolitan housing markets.

This means that most of the HELOC opportunity exists, really, for wealthier homeowners in the most expensive housing markets. This was not the case during the housing boom, when borrowers in any market could syphon off all the equity in their homes—and in some cases inflated equity that didn't really exist. That was a key factor in the housing crash. While many of those borrowers lost their homes to foreclosure, there are millions more who still have these loans and are now in for a new payment shock.

Nearly half of all existing HELOCs that were originated between 2005 and 2007, before the housing crash, are coming up on the end of their draw periods. These borrowers will have to begin paying principal in addition to interest, which is an average of about $250 more per month, according to Black Knight.

"While equity positions are improving, 29 percent of those facing resets still have less than 10 percent equity in their homes, making refinancing their way out of payment shocks problematic," said Graboske. New delinquencies on loans originated in 2005 are already up 44 percent year over year. "This remains a situation that bears close watching," he added.