By Veronica Dagher
Nov. 16, 2022
As high interest rates drive up the cost of borrowing money, more people are tapping the equity in their homes.
Americans took out $66 billion in home-equity lines of credit, or HELOCs, in the second quarter, a 40% increase from a year ago and the largest amount in almost three years, according to data from real-estate analytics firm Attom Data Solutions. These accounts, which allow homeowners to borrow against the value of their house, are making a comeback as higher rates make it less favorable to refinance a mortgage.
A HELOC works like a credit card, but since it is backed by your property generally offers a much more favorable interest rate. The average HELOC rate is 7.7%, according to Bankrate.com, compared with the average 19.04% APR on a credit card and 10.64% average personal loan rate. Owners get a credit line based on their home equity, but don’t have to use all or even any of available funds.
Financial planners say the ready access to money HELOCs provide can be particularly appealing during a time of economic uncertainty—as long as borrowers refrain from treating their home as an ATM. Lenders tend to tighten credit standards during a downturn so it may be wise to apply for a HELOC now if you’re worried about needing the funds later, they said.
“Clients are saying they want a safety net as credit-card bills rise along with unemployment fears,” said Ryan Leahy, regional president and senior loan officer at HomeTown Lenders of Texas.
While HELOCs can provide that financial safety net, homeowners have to understand what they are getting into. Those who fail to repay the HELOC could risk losing their home. A HELOC is different from a home-equity loan, which typically has a fixed rate and gives borrowers a lump sum upfront.
While demand for HELOCs is increasing, some banks are choosing not to offer them due to the risks, said Rick Sharga, executive vice president of market intelligence at Attom. Instead, borrowers often turn to credit unions and community banks to get HELOCs, he said. Big banks such as Wells Fargo and JPMorgan Chase & Co. haven’t resumed issuing new HELOCs after halting them during the pandemic. A Citibank spokesman said the bank temporarily suspended HELOCs, but plans to offer them again next year. Bank of America continues to offer HELOCs, according to the company.
Here’s a rundown of how the accounts work and what financial advisers say are the best ways to use them.
How HELOCs work
To be eligible for a HELOC, your home’s current value usually needs to be at least 15% higher than the amount you owe on the mortgage, said Kate Wood, a home and mortgage specialist at NerdWallet. Each lender may have slightly different terms and requirements, she said.
The maximum size of a HELOC is usually a fraction of homeowner’s equity. For a home valued at $400,000, with $250,000 still owed on the mortgage, a borrower might be able to get a HELOC for about $90,000, Ms. Wood said.
The interest rates on HELOCs are typically variable, meaning they will fluctuate as interest raises change more broadly. Other factors go into the rate, including your credit score, debt-to-income ratio and the amount you are seeking to borrow, Ms. Wood said.
HELOC applications also come with certain fees, which vary by lender, and may include the cost of a home appraisal and title search, along with other expenses that can add up to between 2% and 5% of the total credit line, Ms. Wood said.
Interest paid on a HELOC can be tax deductible, but only if you use the HELOC to pay for home renovations and improvements, said Jacob Channel, senior economist at LendingTree.
You can only deduct interest on up to $750,000 of residential debt—this limit will take into account both how much you owe on a HELOC as well as other types of residence loans like a mortgage, he said.
HELOCs for home improvements
One of the most common uses for HELOCs is to fund home-improvement projects, which have the added benefit of potentially increasing your home’s value. With home prices and mortgage rates both high, many Americans are choosing to renovate rather than relocate, said Dan Butts, a mortgage banker in Charleston, S.C.
Xin Li, who lives in San Francisco, recently used a HELOC to fund a $120,000 kitchen remodel. She is debating whether to move forward with the renovation now or if she should wait to start withdrawing funds from the HELOC until home furnishing and labor prices fall.
Mr. Butts advises clients to only carry a HELOC balance for a short term, typically around 18 to 24 months, due to the product’s variable interest rate.
At the end of third quarter, the average U.S. homeowner had $196,000 in tappable equity, down 9.6% from the second quarter but still up about 10% from the same time last year, according to mortgage technology and data firm Black Knight Inc.
When HELOCs may not be the best option
Jason Blumstein, a financial planner in Englewood, N.J., warns clients against taking out HELOCs for large non-discretionary pure expenses such as a vacation or a wedding. These expenses, while they may provide a short-term emotional high, don’t provide a financial return the way a home improvement might, he said.
Taking out home equity to fund investments can be risky
Many people use HELOCs for funds to start a business, for a down payment on another property or to put into stocks. But financial advisers warn that such investments can be risky.
In recent years, some aggressive investors would take out a HELOC balance at a low rate and invest the proceeds in anticipation of a higher return in the market. This arbitrage is no longer an optimal strategy with HELOC rates more than double what they were a year ago and increased market volatility, said Jordan Slingo, a financial planner in Athens, Ga.
Don’t use a HELOC to invest in the stock market dip, Leibel Sternbach, a financial adviser in Melville, N.Y., is telling more clients lately.
“Not only will you lose most of your profits to loan fees and interest payments but you’ll be taking on excessive risk,” he said.
Write to Veronica Dagher at Veronica.Dagher@wsj.com
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