How much is too much equity debt? It depends

How much home equity debt is too much? The answer depends on how much you owe to other creditors, whether you get a home equity loan or a line of credit, what you're using the money for and whether you have self-discipline.

As rates continue to rise, more and more homeowners will ask themselves how much they can safely borrow with a second mortgage. That's a change from the height of the refinancing boom, when many homeowners refinanced their first mortgages for more than their loan balances and took out the difference in cash. The heyday of cash-out refinancing has passed because rates have risen. Now, more homeowners are using second mortgages (home equity loans and lines of credit) to extract cash from their homes.

The lender is your first line of defense against taking out a loan for too much. A reputable lender underwrites loans based on your ability to pay. "From a credit risk and business standpoint, the business thinks you can afford it," says Anthony Hsieh, president of HomeLoanCenter.com. "Otherwise, they wouldn't approve it for you."

Debt-to-income ratio crucial
A lender determines whether you can afford the loan by comparing your debt to your income. Most lender guidelines limit borrowers to total debt payments not to exceed 45 percent to 50 percent of before-tax income, says Raymond Michaud, who runs Mortgage Center of America in Trumbull, Conn.

An example: Let's say you earn $850 a week before taxes, or about $3,400 a month -- roughly the nation's median household income. Your lender doesn't want the monthly minimum payments on all your debt -- mortgage, equity loan, auto loan, credit cards, student loan -- to exceed 45 percent to 50 percent of that pretax income. So, when figuring out your maximum loan amount, it would seek to cap your total monthly debt payments at $1,530 to $1,700. At the higher end, you're really squeezing your monthly budget.

Here's where another calculation enters the picture: the loan-to-value ratio. Generally, guidelines limit mortgage debt to 95 percent of a home's value. So if you have a house worth $100,000 and you owe $75,000 on your first mortgage, most lenders would cap your equity loan amount to $20,000.