Q: My wife and I bought a row house in Washington, DC, last March for $350,000. It was a fixer-upper and we spent around $50,000 over the 16 months fixing up the place.

I am happy to say that we have finished the renovation work and have recently had the house appraised for $550,000. The increase in the value is a combination of the work we did – my wife is an architect and interior designer – and the location of the property in a surging up and coming area of DC.

My question is this: what are our options now? Should we refinance our loan for $550,000? Would we be able to do so, pay off the $350,000 loan and take some of the money out to invest in other properties? Is our profit on our initial $400,000 investment really $150,000? How can we see or use that money? Thanks for your help in figuring this out.

A: Did you think “fix it and flip it” went out in 2007, as the housing market began to crater?

I received this letter recently, and what struck me is how the reader’s question – his living the American Dream – falls at the absolute crux of the housing market collapse.

Many homeowners bought homes and tapped into their equity to finance fancy lifestyles, other investment real estate purchases, and even college tuitions. They refinanced their properties as the values surged. When home values collapsed, millions of homeowners were caught “underwater,” that is, with houses worth less than the mortgage amount.

Some industry observers estimate that as many as one-third of all homeowners with mortgages are living in homes worth less than the mortgage value. As more jobs are lost, many of these homeowners are simply walking away from their properties, which why we’re seeing a surge in foreclosures. (As jobs continue to be lost, more properties will be lost to foreclosure.)

This reader clearly bought the property recently, after the market had declined in general. With his wife’s expertise, they’ve made some smart moves – enough so that an independent appraiser calculates that they’ve built in a fair amount of home equity.

But when it comes to tapping your equity, you’ll be operating in the new world of real estate.

1. Can you afford a home equity loan? Taping into your equity first requires that you can actually afford to do so. In today’s marketplace, the reader would have to earn approximately $150,000 to $175,000 per year to afford a $450,000 mortgage. A few years back, you might have only needed to earn $45,000 for that same loan, if you structured it as a stated income pay-option adjustable rate mortgage (ARM).
2. Can you get anyone to give you a home equity loan? In the current mortgage market it may be difficult, if not impossible, to get access to your home equity. It’s extremely difficult to get a bank to do a “cash-out” refinance, which is where you get a mortgage that is bigger than the one you’re paying off, in order to cash out some of your equity. That’s not to say there aren’t any banks out there doing these loans. It just means they can be quite hard to find and obtain.
3. How big a loan do you need? If you’re looking for a jumbo loan (any mortgage amount over $417,000, except in a few limited high-cost areas like San Francisco, is a jumbo loan), you may find it extremely difficult to get. With a jumbo loan, you’d still need to have at least 20 percent equity in the property (and possibly more). If your home is truly worth $550,000, you’d need to have at least $110,000 in equity. (Some banks are requiring far more equity than that for larger jumbo loans.) If you obtained an 80 percent loan on the assumed value of $550,000, you would have about $110,000 in equity to tap. But you would have to find a lender willing to give you a second loan or home equity loan.
4. Try a multi-level refinance. The reader could try applying for a loan for $417,000, which is the maximum level for a conventional loan, and more than he’d need to pay off his existing loan. (This would be a cash-out refinance, so, re-read Step 2.) The next step would be to look for a lender who will provide a home equity line of credit for an amount above that.
5. Is it easier to lock in a bigger home equity line of credit and keep your current mortgage? If a cash-out refinance isn’t an option, consider a home equity line of credit. Shop around with local mortgage brokers, a credit union (if you belong to one or can join one) and the big banks.

The reader’s final question is most telling: He wants to know how he can see or access his equity. The simple truth in today’s new world of real estate finance is that you may not be able to readily access your equity.

The big lesson of this housing recession is that home equity is fleeting. Buying a home, renovating it, and then tapping into the equity was the game in 2004 and 2005.

These days, when housing has lost 20 percent to 50 percent (in Arizona) of its value, mortgage lenders who have been burned by billions in write-downs on badly-performing loans are extremely nervous about extending credit. That’s why Fannie Mae and Freddie Mac are now run by the federal government, and why together with FHA, they are backing something like 80 percent of all home loans.

Follow-up. After I sent a slightly shortened version of this column to the reader, he sent back this response: “Sounds like tapping into my equity may not be such a good idea. Should we sell?”

When it comes to real estate, what matters is what is happening on your own block. If you’re competing with tons of other homes for sale, including foreclosures, you may just want to wait a year or so, while the real estate market calms and settles down.

And if you want to benefit from the tax law that allows you to keep up to $500,000 in profits tax free when you sell, you have to live in your home for at least 2 years. My guess is that this reader will stay put for awhile.

While some people are having luck refinancing properties, here’s another article on How To Prepare For A Mortgage Refinance