What to Know if You’re Tempted to Borrow From Your Home EquityReturn to Blog
Record increases in home prices are pushing up the number of equity people have in their abodes. For many Americans, they can borrow more against what is often their most substantial asset. However, financial experts caution you should think carefully before making such a move.
The average mortgage holder currently has about $185,000 in home equity to tap, which is the amount they can access while still retaining a 20% stake, according to mortgage research from Black Knight.
According to Black Knight, Homeowner equity is now an aggregate of $9.9 trillion. After a 35% gain in 2021 worth $2.6 trillion, the highest annual increase on record, beating a $1.1 trillion bump in 2020.
The hot market has made it an attractive time to sell for some homeowners. Although, rising prices, as well as high rents, can make it difficult for people to relocate. Instead, many homeowners have chosen to draw money from their homes, which they can traditionally do in three ways. That includes so-called cash-out refinancing home equity lines of credit or HELOCs, and reverse mortgages, often offered through home equity conversion mortgages or HECMs.
More homeowners, especially those age 62 and over, have been eager to extract equity from their homes amid current market conditions, research from the Urban Institute found. The combined number of those loans to seniors increased to 759,000 in 2020, from 647,000 in 2018.
Primarily, the increase was pushed by cash-out refinances. Following a new, larger mortgage replaces the previous one. For those transactions, the median loan rose to $205,000 in 2020, from $180,000 in 2018, according to the Urban Institute.
With borrowing costs expected to rise as the Federal Reserve raises interest rates, that may increase the incentive for homeowners to make these transactions now.
As rates kick up, the market may shift from being predominantly cash-out refinance transactions to more HELOCs and home equity loans in the coming years.
To cash out refinances - you may need to refinance your entire mortgage, which may not be economical for many consumers, as their payments would likely go up. A HELOC may be a better option for someone remodeling their bathroom, for example, and needs to borrow only $25,000. While that may have a higher interest rate, the underlying principle on that loan is much lower.
Maintain 20% equity:
When deciding whether to borrow from your home, it’s important to remember that lenders typically want you to maintain a 20% equity stake, said Greg McBride, chief financial analyst at Bankrate.com.
“Just because you have home equity doesn’t mean you can borrow from it,” he said. The temptation can still be intense for people who want to draw money to pay down credit cards or fund home improvement projects.
Exercise caution consolidating debts:
According to Bankrate, current credit card rates are hovering at around 16%, while mortgage rates are steady at 4%.
McBride cautions against consolidating your credit card debts with a home equity loan as a permanent solution. If the debt results are from a one-time event, like a medical bill or period of unemployment, it could be helpful. But if it’s indicative of your lifestyle, odds are you will still run up a balance under a home equity loan.
Consider improving your home:
Home improvement projects may also be a reason to tap your home equity. While some of Sachs’ high-net-worth clients have pursued these transactions for home improvements or invest in higher-yielding investments, these strategies are not for everyone. You should be financially savvy and have the ability to take on risks. Moreover, it is impossible to know when the absolute bottom to borrow will be. Still, we may look back in five years and be envious of current interest rates.