Loans

You’re living in a home equity piggy bank. Should I take advantage of it?


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If you bought your home before you heard the term “COVID-19,” you probably have an asset worth much more than you paid for it.

Home prices have gone up quite a bit in recent years (about 20% last year) as demographics, remote work, and stiff competition have fueled demand for homes across the country. That means homeowners have a lot more equity than you might expect.

You can use the equity in your home in a variety of ways, borrowing against it for cash that you can use for all sorts of things. The question is, is it wise to treat your house like a piggy bank?

“The temptation is going to be there,” says Mark Hinshaw, co-founder and president of Candor Technology, a mortgage technology company. “They think they have suddenly won the lottery.”

Experts say there are ways to borrow wisely against your home equity through loans and home equity lines of credit (HELOCs), but beware of the risks, meaning, just like a mortgage, not paying could cost you money. home.

“This can be valuable money for people, especially people who have owned their home for a long time,” says Linda Sherry, director of national priorities for Consumer Action, a national advocacy group. But he warns borrowers to be careful taking out money for non-essentials. “If it’s not a need and it’s just some kind of desire or longing, you really should ask yourself: Is this something that is wise?”

Here are some things experts say you should consider before tapping into all that capital.

houses are very valuable

Nearly half of residential mortgaged properties in the US were deemed “equity-rich” in the first few months of 2022, according to real estate data firm ATTOM. That means the value of the property was more than double what was owed on all loans secured by it, such as a mortgage.

Property values ​​have risen due to the incredibly active real estate market in recent years. Cutthroat competition for a limited number of available homes means that any home that comes on the market is bound to fetch a higher price than expected. There are signs that they may be cooling off a bit, as mortgage rates have risen sharply since the beginning of the year, but home prices have yet to decline or have even slowed significantly in much of the country.

The fleeting nature of the housing market is one reason to be wary of that capital windfall, Sherry says.

“Houses go up and down in value,” she says. “I think she should look at it as if the amount she could sell her house for might go down in the future and she doesn’t want to borrow too much because she would have to pay back an unusually large amount at closing. addition. You could end up underwater in a really bad scenario, where at closing you owe more than you could actually sell the house.”

While homeowners may take comfort in the idea that they are “equity rich,” it is not as if their homes are filled to the brim with $100 bills. Hinshaw compares it to a company that owns a lot of assets but doesn’t necessarily generate that much cash on its profit and loss statements. “That’s a rich balance sheet,” he says. “That is not rich in profit and loss.”

What can you do with the equity in your home?

Getting a home equity loan or line of credit is one way to get the cash you need for a big expense, but experts say some uses make more sense than others.

Home improvement

The most cited way to use a home equity loan is to put that money towards home repairs or improvements, whether they are necessary, like replacing a leaky roof, or high-value projects, like a kitchen remodel. .

Needed improvements are logical uses for home equity loans, Sherry says. Repairs or improvements that could increase the value of the home also make sense if you plan to sell it soon. But don’t assume it will all be worth the investment when you go to sell.

“Certain home improvements are known to not generate as much equity as others,” says Sherry. “If you were to spend $40,000 on a new kitchen, would that increase the value of your home by $60,000? Maybe, but maybe not.”

debt consolidation

Another popular use for home equity loans and HELOCs is to consolidate higher-interest debt, such as credit card debt and student loans. That may make sense, but be careful, says Vikram Gupta, director of fair housing at PNC Bank.

“If you’re a homeowner with existing debt, using your home to help pay off high-cost existing debt is a fantastic idea if you do it sensibly, prudently,” and if you don’t overdo it, he says.

Not all experts agree that debt consolidation is worth putting your home at risk. There are other ways to tackle higher-cost loans without putting your home in jeopardy, Sherry says. “Take your credit card with the highest rate and act in a way that you pay more than what is required, as much as you can, and pay that way instead of borrowing against your home,” she says.

for other purposes

Some experts say you should consider having a HELOC on hand before any planned home improvements or other major expenses, so you can use it if you need it. “If you’re a homeowner, you’re using the smartest equity you can. I don’t like when people refer to that as consumers using their home like a piggy bank,” says Jim Albertelli, CEO of Voxtur Analytics, a real estate technology company.

Be careful, as that can be “a little tempting for a lot of people,” says Sherry. “Remember that having that credit line there doesn’t necessarily mean you have to pull it every five seconds. It should be something you are very disciplined in.”

One important thing to keep in mind is that you must be able to pay off this debt in the future. “If they’re not confident in their ability to generate future cash flows, they should wait,” says Hinshaw. “There is no point in being overleveraged.”

What are the risks of home equity loans?

Home equity loans and HELOCs have many advantages over other types of debt, such as personal loans and credit cards. They have lower interest rates and generally more favorable terms. But those benefits exist because if you don’t pay, the bank can take your house.

“That risk always remains when you use your home, but used wisely and sensibly, it’s a more cost-effective way to borrow without collateral,” says Gupta.

know your loan

It’s also important to understand how the loan you’re using works and what the pros and cons are. Sherry cautions against interest-only loans and HELOCs, where your down payments only cover interest and don’t reduce outstanding principal. “You’re going to end up deeper in debt and what they ask you to pay back won’t be enough to pay off the principal you borrowed,” she says.

Lending standards have changed

Home equity loans played a big role in the financial crisis of the 2000s, as lax credit standards and high housing costs led people to treat their home like an ATM. That is no longer the case, experts say, as regulations imposed in the wake of the crisis mean banks and other lenders are doing their due diligence to ensure borrowers can repay.

pro tip

Going through the paperwork to qualify for a loan can be daunting, but it pays to have the confidence of knowing you can pay it back.

“There were no regulations. The lenders were lending very freely without verifying the borrower’s repayment capacity. Clients took on excessive debt, used their homes as piggy banks,” says Gupta.

One key is to make sure your lender supports the loan by reviewing your credit history and requesting documents, Sherry says. “It can be annoying to be asked all these personal questions about his finances, etc., but in the end this is to protect him,” she says. “If they gave you a loan without asking a lot of questions, that’s a red flag.”

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