August 17th, 2018 10:16 AM by Jackie A. Graves, President
home prices across the U.S. have boosted homeowners’ equity to record-setting
levels. That means you can convert your home’s increased value into cash.
Seems like a no-brainer, right?
there’s more to the story. Many homeowners are reluctant to use home equity
loans to tap their homes like an ATM. And while they have valid reasons
for being cautious, homeowners who are short on cash could be missing out on
As equity surges, HELOCs lose popularity
tappable equity — the amount they’re able to draw in cash from increased home
values — jumped by $380 billion (7 percent) in the first quarter to $5.8
trillion, according to the latest Mortgage Monitor Report from Black Knight, a
real estate and mortgage data analytics firm. That’s the largest growth in a
single quarter since 2005.
the past 12 months, the average homeowner with a mortgage gained $14,700 in
usable equity and has $113,900 overall.
meteoric rise in values, the share of total equity Americans have pulled from
their homes hit a four-year low in first quarter 2018. Homeowners
with mortgages withdrew $63 billion in equity using a cash-out refinance or a
home equity line of credit, or HELOC,
in the first quarter. That’s a 7 percent decline from the fourth quarter and up
1.1 percent from a year ago, Black Knight found.
Even though rising rates on first-lien mortgages usually spurs more HELOC
lending because people don’t want to refinance out of lower-rate loans, the
volume of equity taken out with a HELOC fell to a two-year low, according to
still see their homes, which is often their largest investment, as a source of
cash. Cash-out refinances spiked 5 percent to 70 percent of total refinance
transactions in the past year. Black Knight found that nearly half of
homeowners who opted for a cash-out refinance increased their interest rate in
preference of cash-out refinancing over a HELOC seems counterintuitive for a
short-term cash need. Homeowners who need money quickly could benefit from a
HELOC if they use it the right way — and understand what they’re getting into,
rates, lingering fears stifle HELOC growth
waned in popularity in recent years. For starters, a rise in short-term
interest rates is off-putting for potential borrowers because HELOCs come with
variable interest rates. Mortgage rates have been largely on the upswing,
making it more expensive to borrow.
for HELOCs: the new tax law that removes the mortgage interest deduction for
loans that aren’t used for home improvement projects. If you plan to use a
HELOC for other purposes, the loss of that tax benefit makes HELOCs less
appealing, especially compared with other alternatives, says Greg McBride, CFA,
chief financial analyst with Bankrate.com.
consumers with strong credit profiles, there are mid-single digit interest rates
available on unsecured personal loans,” McBride points out. With a personal
loan, “a borrower can have funds in hand within 72 hours, presenting a
convenient alternative at comparable interest cost.”
behind by the housing crash have stifled HELOC growth in a post-recession
recovery, says Mary Jane Corzel, senior vice president, retail credit center at Bryn Mawr Trust in Bryn Mawr,
crash, people used HELOCs for everything,” Corzel says. “When the housing
market crashed, they were underwater. There is muscle memory among borrowers
who were caught in a bad situation then, and may have recovered and have equity
now. People are more conservative today than they were before.”
how HELOCs work
consumers’ fears may stem from misunderstanding how HELOCs work and who should
use one. A HELOC is a bit like a credit card where you get a line of credit for
a set timeframe, usually up to 10 years, called the “draw period.” During this
time, you can withdraw money as you need it.
Courtesy of Black Knight
choose from an interest-only draw period, or one where you pay interest and
principal, which pays off the loan faster. As you pay down the principal, your
credit revolves and you can use it again until the line expires. You then enter
the repayment period, which can last up to 20 years. You’ll pay back the
remaining balance, as well as any interest still owed.
A HELOC has a
variable interest rate that is tied to a benchmark interest rate, such as The
Wall Street Journal Prime Rate. As the prime rate fluctuates, so does your
HELOC interest rate. That means your payments can go up or down, too, depending
on the interest rate and how much you owe. Some lenders even offer a fixed-rate HELOC option.
rates climb, HELOCs tend to be more popular compared with the costs of a
complete cash-out refinance, says John Pataky, executive vice president and
chief consumer and commercial banking executive at TIAA Bank. With a cash-out
refi, you may have to pay off a first mortgage with a lower interest rate,
replacing it with a higher rate for the life of the loan.
“It’s a much
better financial outcome to leave the lower mortgage rate in place, and end up
with a blended-rate situation that’s much lower than what the cash-out
refinance would yield,” Pataky says.
risk and your financial discipline
If you have a
good read on your income flow throughout the year and are adept at managing
money, the variable interest on a HELOC won’t be as shocking, Corzel says. If
you earn most of your income from commissions or bonuses and know you’ll earn
more during certain quarters, you can better time your interest payments to
match those income surges, she adds.
A HELOC isn’t
without risks. The biggest downside is if you run into financial trouble and
can’t repay your loan, you could lose your home. Just like a traditional
mortgage, a HELOC comes with servicing fees, terms and interest. Lenders will
look at your income, employment, assets, credit and financial history, and
order a property appraisal to determine your home’s value, Pataky says.
who has substantial equity in their homes should tap it. Using a HELOC to
fund vacations, buy a car, or extravagant purchases is a sign you’re
living beyond your means, McBride says.
home equity product that puts your home on the line requires strict discipline
and sticking to a repayment schedule, McBride says. Homeowners who don’t have
control over their spending or debt and use their home as a piggy bank may dig
themselves a deeper hole with a HELOC.
credit card debt came from a pattern of overspending that hasn’t been cured,
then [a HELOC] is a bad idea,” McBride says. “But if it resulted from a
one-time, unforeseen event, such as medical expenses or prolonged unemployment,
then using a fixed-rate home equity loan to minimize the finance charges and
have a definitive payoff date can be a good move. The revolving, open-ended
nature of HELOCs could invite additional borrowing and drag out the repayment
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