People are still borrowing from their home assets as they used to. This is good.
We are talking about Home Equity Credit Lines, or HELOCs. It surged in popularity in the early 2000s and declined after 2008. In recent years, HELOCs have been overshadowed by cash-out refinancings, another way to get equity.
Now HELOC is creeping. The number of HELOCs increased slightly in the second half of last year. Borrowings from HELOCs have also skyrocketed. In the fourth quarter of 2022, the homeowner owed him $336 billion against his HELOC balance, up from $318 billion a year earlier.
As HELOCs emerge from a long dormancy, new generations of homeowners may be unfamiliar with HELOCs and require some education.
Advantages of HELOCs
Don’t worry if your HELOC comes back. Yes, they went down by the time subprime mortgages turned into Kabrooky. But HELOCs are not subprime loans and are useful for a variety of uses.
A HELOC is a second mortgage that allows you to keep your current mortgage. You can borrow from HELOC and pay it back monthly like a credit card. HELOCs are traditionally used to pay for home improvements, allowing owners to increase the value of their homes by borrowing against their assets. This is a powerful motivator today with many homeowners preferring to repair their homes and maintain low mortgage rates rather than buying and selling better homes at higher interest rates. This is a phenomenon known as the “interest rate lock-in effect”.
Margherita Cheng, a certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland, says HELOCs are a great way to pay for a series of long-term renovations. One year it’s the bathroom, the next year it’s the kitchen. She has clients drawn from her HELOC.
Some people open a HELOC, never borrow from it, and set aside a line of credit just in case.
“I almost always think of HELOCs as secondary emergency funding,” said Tim Melia, a certified financial planner and principal at Embolden Financial Planning in Seattle, in an email. He recommends withdrawing from emergency savings first and then turning to HELOC after that account is depleted.
Suspicious uses of HELOC
Standard advice is to use HELOC and avoid working at scale. “Don’t do it for consumption, like a new SUV or a trip or a wedding,” Chen says.
What about in-between expenses that aren’t temporary like vacations or not as significant as renovating a bathroom? For example, college expenses, or consolidating credit card debt? I don’t want to say Because everyone’s situation is different.
For college expenses, Melia prefers student loans. He admitted that using HELOC to consolidate credit on his card debt looks tempting, but that it takes self-discipline to pay off the debt without increasing the card’s bill. .
Note that when you use HELOC, you are using your home as collateral. So if you don’t pay, you could lose your home to foreclosure.
“There are some downsides to borrowing against home equity,” Marcus P. Miller, a certified financial planner at Mainstay Capital in Jacksonville, Fla., said in an email. “First, because the amount of debt increases, there is a risk of falling behind on loan repayments or facing financial hardships if you are unable to make payments. can be difficult to refinance.”
Several financial planners emphasized the need to know how to pay off HELOC balances if principal and interest were to be paid. For example, if you borrowed money while working and had to pay it back when you retired with less income, what would your plans be?
Why HELOC is back
Mortgage nerds talk about “tappable equity.” This is the total amount of housing equity that a homeowner can borrow. During his first two years of the pandemic, tappable equity surged as home prices went into beast mode. Homeowners had about $9.3 trillion in equity available for borrowing as of February, according to data analytics firm Black Knight. Nonetheless, this was an increase of $3.4 trillion over three years.
So the homeowner has equity to borrow. And at current interest rates, HELOCs are usually better than cash-out refinances.
A cash out refinance replaces your current mortgage with a new mortgage that is more than you owe. You will receive the difference in cash. With mortgage rates up more than 3 percentage points since his early 2022, cash-out refinancing has become obsolete.
Comparison of HELOC and cash outflow
Consider the hypothetical example of a person taking out a $300,000 mortgage at 3% interest in mid-2021. Now this homeowner wants to borrow her $50,000 from his stock. Among the options are to keep the current mortgage and borrow $50,000 from her HELOC, or do a $350,000 cash out refinance at today’s higher interest rate.
Maintaining a mortgage and adding a $50,000 HELOC at 9% interest costs $1,898 per month in principal and interest. (This assumes the borrower pays off her HELOC over his 10 years.)
Obtaining a $350,000 cash-out refinancing at 6.5% costs $2,212 in principal and interest. That’s $314 more per month (not to mention thousands of additional interest on the original $300,000).
Even if the original mortgage rate were higher at 4% instead of 3%, adding a HELOC would still be $147 a month cheaper than refinancing cash out in the above scenario.
HELOCs are a valuable financial tool when used responsibly, and their recent revival may be just beginning.
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Holden Lewis writes for NerdWallet. Email: firstname.lastname@example.org. Twitter: @HoldenL.
The article “HELOCs are back, here’s how and why to use them” originally appeared on NerdWallet.