Biggest mistakes

Homeowners treated their houses like piggybanks or automated tellers during the housing boom years, withdrawing equity in the form of cash whenever they wanted to buy something. Many of these homeowners now owe more than their homes are worth, a condition known as having "negative equity," or being "underwater."

Negative equity limits your ability to sell a house to get out from onerous mortgage payments, or to move to take a better job or to relocate to a better school district.

People abused their home equity in a couple of ways. Some turned equity into cash by getting ever-larger home equity loans or lines of credit. Others took advantage of cash-out refinancing as a way to collect excess cash to spend.

During the boom, it worked this way: A homeowner borrowed $100,000 to buy a $120,000 house. A few years later, when the house more than doubled in appraised value because of the housing bubble, the owner did a cash-out refi for $200,000 and pocketed more than $100,000 in cash.

The money was quickly spent on Harleys, Hummers and holidays in Hawaii.

"Too many consumers thought of their home equity as easy-access ATMs," says Jeff Lazerson, president of Mortgage Grader, a Laguna Niguel, Calif.-based mortgage technology and management company. "Many thought they were individual geniuses about the infinite value of their homes, not understanding that they were just riding the high tide that turned out to be a crashing tidal wave."

To extend the metaphor, those are the homeowners who are underwater now.

Smart strategies going forward

Lenders are also reluctant to approve cash-out refinances. Many lenders won't approve a cash-out refinance for more than 80 percent of the home's appraised value, no matter how high the borrower's credit score.

Someday, lenders will loosen today's strict lending guidelines. When they do, it would be prudent to remember that house prices can -- and do -- fall. Borrowing against all of a home's equity can limit your options when prices sink.

To learn more, visit Bankrate's Home equity center.

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