Home Equity Levels Are at All-Time Highs - Here’s How to Tap Into Yours
Americans are sitting on a pile of home equity after a record surge in home prices lifted real estate values of surrounding properties – even those that aren’t on the market.
The amount of so-called tappable equity – meaning the amount homeowners can borrow against while still maintaining a 20% equity cushion required by most lenders – grew $1.2 trillion in the first three months of the year alone, the largest quarterly gain on record, Black Knight said in a report last month. In total, Americans held $27.8 trillion in home equity in the first quarter, an all-time high, according to Federal Reserve data.
While the record gains in home prices over the last two years have made it tough to be a first-time homebuyer, they’ve added to the wealth of people who already have homes, said Ben Graboske, president of Black Knight Data & Analytics. The home appraisals that determine the size of a home equity loan owners can get are based on “comparable sales,” meaning recent sales of similar properties in a neighborhood.
“It really is a bifurcated landscape – one that grows ever more challenging for those looking to purchase a home but is simultaneously a boon for those who already own and have seen their housing wealth rise substantially over the last couple of years,” Graboske said.
So how can homeowners tap into their home equity to make home improvements, fund college tuition, pay off medical expenses or cover other expenses? There are several options, including home equity mortgages with variable and fixed rates.
Get a Fixed-Rate Home Equity Loan
A home equity loan is a so-called junior mortgage, meaning if your home goes into foreclosure the lender stands second in line behind the holder of the property’s primary mortgage to try to recoup their losses.
One type of home equity loan is a fixed-rate mortgage with a term ranging from 5 years to 30 years. The cash is typically distributed as a lump sum.
Home equity loans incur upfront fees and costs, so it’s important to shop around and consider those in the total cost of the loan when evaluating if you can afford to repay the loan.
Apply for a Home Equity Line of Credit
A home equity line of credit, or HELOC, also taps into your home equity, but instead of a lump-sum loan it works like a debit card. Homeowners qualify for a maximum amount, say $80,000 or $100,000, and they can draw against those funds as needed, with payments based on the amount they’ve used.
“A HELOC allows the borrower the flexibility to use some or all of the line, as needed,” said Scott Smith, an assistant vice president at SECU, Maryland’s largest credit union.
Unlike a lump-sum home equity loan, you don’t have to pay back the entire line of credit unless you use the entire amount. Instead, you pay off what you borrow. So if you use $20,000 after being approved to draw $80,000, you only pay off that $20,000.
Rates typically are based on a designated margin that’s added to the so-called prime rate, which is the rate banks charge their most creditworthy borrowers. For example, a “prime plus 1% HELOC” would be the prime rate, which changes in tandem with the Federal Reserve benchmark rate, plus 1%.
One thing to keep in mind is: If the economy takes a turn for the worse, the lender can shut down the unused portion of the credit line so borrowers can’t use the full amount. Of course, homeowners still have to pay back the amount they’ve already used.
Do a Cash-Out Refinance
With a cash-out refinance, you get a new mortgage on your existing property that’s larger than the old loan and get a lump-sum check at the closing. Lenders typically require borrowers to leave a 20% equity buffer in properties, so it’s usually not possible to max-out the value of a home.
“With mortgages, it’s a fantastic way for someone to unlock value in a property,” said Boaz Leviatan, CFO and credit manager at Lendai in Miami.
While the process is a bit more involved than telling your mortgage lender to give you the money, it can be less exhaustive than trying to sell your property, get the cash and find a new home at an affordable price so you can pocket some of that cash, he said.
In addition, a cash-out refinance is not a tax event.
“If you sold, you might have to pay capital gains tax,” Leviatan said. “But, in this case, you don’t need to pay tax.”
The surge in mortgage rates during the past year have made cash-out refinancings less attractive, as the new mortgage will carry a higher interest rate and bigger monthly payments. The cash you could receive may look attractive, but the amount you pay during the loan’s term can be daunting, SECU’s Smith said.
“Refinancing a $250,000 mortgage from 3% to 5% adds over $103,000 in additional interest over the life of the loan,” Smith said.
Take Out a Reverse Mortgage
For homeowners age 62 and older, a reverse mortgage allows homeowners to borrow money using their home as collateral. Unlike a traditional mortgage, a reverse mortgage does not have to be repaid every month. Instead, it can be paid when the homeowner no longer lives in the home, often by selling the house and paying off the reverse mortgage.
It’s important to note that, unlike a traditional mortgage, a reverse mortgage accrues interest and fees over the life of the loan, so the amount due at the time of repayment will be higher than the original loan balance. It’s important for homeowners and their heirs to plan for this when the time comes to pay off the reverse mortgage.
What to Avoid When Tapping Into Home Equity
Before making any moves to tap into their home equity, homeowners should carefully review their finances and make sure this is the right move for them, said Vik Gupta, head of home equity for PNC in New York.
“They should make sure they are comfortable with the purpose of the funds they are withdrawing,” Gupta said. “Borrowers are securing the loan with their home, and they could risk losing it if they can’t pay back the loan. Hence, they should feel confident in their ability to repay the loan and borrow funds prudently.”