You might not feel it yet, but if you’re an American homeowner, you’re probably a little richer after the skyrocketing rise in house prices last year. But how do you tap into your new found wealth? And should you?
US homeowners gained an average of $55,300 of their home’s value (minus their mortgage) in 2021. In some particularly hot cities, like Denver and Miami, the increase was nearly $80,000, while in Los Angeles and San Francisco, where prices are high, it was over $110,000.
That’s a remarkable jump given that it took three to four years to see gains of $50,000 in previous bull markets, said Frank Nothaft, chief economist at real estate analytics firm CoreLogic.
For anyone who wants to sell, it’s a godsend – just find a buyer and turn that appreciation into cold hard cash. But what if you’re happy to stay put?
With all of the current market volatility, inflation, and other economic uncertainties, it’s only natural to want to capitalize on those gains now, perhaps by borrowing against your newly increased equity (the difference between the current value of your home and what you owe on your mortgage.)
Is it safe, however, to use your home as an ATM, especially as fears of a recession loom? It can actually be a smart game, if you use the money wisely and choose the right loan product.
The two main options for tapping into equity are to refinance a mortgage or acquire a home equity line of credit. For the first, you use the higher value of your home to get a larger mortgage at a fixed interest rate, pay off the original smaller loan with the proceeds, and pocket the difference.
But most people who could benefit from such “withdrawal rebates” did so before interest rates started to rise.
So let’s take a closer look at the home equity line of credit. If you’re looking to do home renovations, tapping into your home’s equity can be a prudent way to do it. A line of credit usually makes the most sense because you don’t have to know exactly how much you’re going to spend.
You are allowed to borrow a certain amount at an interest rate that usually floats with the market and then you can withdraw the money as needed. (With a withdrawal refi, you receive a sum of money all at once, whether you plan to use it all or not.)
If you’re in good financial health – that is, you’re doing everything advisors recommend, such as setting aside money for retirement – and you plan to use that money for, for example, improve your home office situation or improve your backyard, go for it. You will create more value in your home and also make your life more enjoyable.
While it’s always scary to borrow against equity that has magically appeared over the past year (could it disappear just as quickly?), take comfort in the fact that – thanks to the housing crisis than 15 years ago – we have a lot more guardrails these days when it comes to borrowing against home equity. Banks limit the amount you can withdraw and they need more documents to be eligible than before.
Also, unlike 2007, the continued tight housing supply means that while home price appreciation may slow, prices are unlikely to fall any time soon. (Beware, though, if you’re in a so-called Zoom City that’s seen huge price hikes thanks to an influx of remote workers — your housing market might be more vulnerable as more and more more people are returning to the office, points out Freddie Mac economist Len Kiefer.)
Some uses of home equity can be riskier. For example, a line of credit might come with an initial rate of around 4%, so using it to pay off high-interest credit card debt seems fine in theory.
If you’re a disciplined spender and are paying off a long-standing debt or maybe a big one-time expense, you’re getting a great deal with the lower interest rate. But if you’re likely to see those paid-off balances as a chance to miss out and spend more, using your home to fund credit card debt could land you in trouble, especially if the loan rate increases significantly.
Another caveat: home equity lines of credit usually only require you to pay interest for the first few years. Thus, borrowers may suffer a double whammy if the rate resets higher and they also have to start repaying their loans.
Tapping into the equity in your home to meet your monthly expenses, especially in a time of rising gas and food prices, can also be dangerous. The equity in a property is not really suitable for current and daily expenses.
Once you have access to that tempting pile of cash through a line of credit, it can be hard to stop coming back to it, and you might end up borrowing more than you planned. Also, keep in mind that the best rates and terms for home equity products are usually reserved for those in the best financial position. If you are having difficulty, the conditions of the banks may not be so attractive.
While lines of credit typically come with much lower closing costs than a cash refinance, the biggest annoyance is their adjustable rates and the difficulty of handling larger payments down the road. For this reason, some banks offer the option of withdrawing a fixed amount at a fixed interest rate under the line of credit, which can offer the best of both worlds.
Another option to avoid inflated payments is to pay more than the minimum interest amount required at the start of the loan, says Sophia Bera, a certified financial planner in Austin, Texas.
For the best deals, consider working with smaller banks and credit unions. They want the business and may be more comfortable than the big banks with keeping your loan on their balance sheets.
Finally, Bera says she’s advised clients who might change jobs or start their own business to apply for a line of credit now — before their incomes change — to get the best rates — especially if they don’t want to. dip into their savings. It has merit. In a topsy-turvy world, a potential lifeline amid major changes isn’t such a bad idea.