American homeowners have accrued hundreds of thousands of dollars in home equity and they’re increasingly borrowing against that value, even though interest rates remain high.
Home equity, the difference between your home’s value and what you owe on your mortgage, has ballooned as home prices have risen. American homeowners with mortgages have about $315,000 in home equity on average, or almost $129,000 more than they did at the onset of the coronavirus pandemic in 2020, according to CoreLogic, a property data firm.
“Homeowners are sitting on a mountain of equity,” said Greg McBride, the chief financial analyst at the finance site Bankrate.
Balances on home equity lines of credit, or HELOCs — a type of second mortgage that lets homeowners use their equity as collateral — are on the upswing, having risen 20 percent since 2021, according to a recent analysis by the Federal Reserve Bank of New York.
And earlier this month, CoreLogic reported that home equity loans — second mortgages with a fixed interest rate and set installment payments — surged in the first half of this year, perhaps because average rates on those loans have been lower than the rates on lines of credit.
Selma Hepp, the chief economist at CoreLogic, wrote in a report in September that the rise in home equity “has served as an important financial buffer in times of uncertainty.”
“It’s almost like a savings account,” she said in an interview.
It’s not clear, though, whether most borrowers are tapping their equity for discretionary reasons — say, a nicer kitchen — or out of necessity, to manage higher living costs. “That’s the part we don’t know,” Dr. Hepp said.
And some homeowners who may simply want to hang on to low-rate mortgages are staying in their homes and using home equity loans to fund renovations or expansions. “It’s not all about being squeezed,” she said.
Lenders like Bank of America and Citizens Bank say clients report home improvement and repairs as the top reasons for taking out home equity lines of credit. That is followed by debt consolidation, in which borrowers pay off high-interest debt and make one payment at a lower rate.
A HELOC can be attractive to homeowners who have low-rate mortgages. It acts as a sort of credit card: You can draw against it as needed, repay the debt, then borrow again. Lenders set a maximum borrowing limit based on the value of the home — typically, no more than 80 or 85 percent of the property’s value, taking both the first mortgage and the line of credit into account. (If your home’s value is $400,000, 85 percent is $340,000. If you still owe $250,000 on your mortgage, you would subtract that balance, arriving at a maximum credit line of $90,000.)
The interest rate on the line of credit is variable, so it can go up or down as interest rates fluctuate. Typically, funds are borrowed during a “draw” period, often 10 years, during which only repayment of interest is required. After that, both principal and interest on balances must be repaid as a fixed-rate loan at prevailing rates, often over a span of 20 years. (Some lenders may allow borrowers to convert part of the draw to a fixed interest rate.)
Borrowers are probably turning to these lines of credit because higher mortgage rates have made options like “cash out” mortgage refinances unattractive, the New York Fed’s report said. With a cash-out refinance, borrowers turn home equity into cash by taking out a larger, new mortgage to pay off the old loan, freeing up the difference to spend.
But a majority of homeowners borrowed at low interest rates available before 2022 and have mortgages with rates below 4 percent. That means taking out a new first mortgage would be more expensive.
Mortgage rates are influenced by a variety of factors and remain higher than the ultralow rates that most borrowers currently enjoy on their home loans, even as the Federal Reserve began cutting its key interest rate in September as inflation eased. The average rate on a 30-year, fixed-rate mortgage was 6.44 percent as of Oct. 17.
Rates on home equity financing are more directly tied to the Fed’s rate. As a result, they are expected to fall, albeit gradually, if the Fed continues to cut rates.
Even though interest rates on home equity lines currently average over 8 percent, they are still far lower than double-digit rates charged by credit cards. An analysis from the Federal Reserve Bank of Kansas City, focusing on the Rocky Mountain states, found that borrowers were tapping home equity partly to consolidate high-interest credit card and personal debt. Typical households show an “immediate” drop in levels of that debt upon opening a HELOC, the report said. But the reduction of about $2,500 is much smaller than the typical draw on a new HELOC of about $40,000, suggesting that debt consolidation isn’t the “primary” reason for taking out the line of credit.
Nicholas Sly, an economist and Denver branch executive with the Kansas City Fed, said lenders reported that borrowers also used the lines to help pay for home repairs, such as replacing roofs after hail damage or fixing heating and air conditioning systems.
Financial advisers often recommend using HELOCs as a safety net. “It’s another line of defense if you need cash immediately,” said Joni Alt, a senior wealth adviser at Evermay Wealth Management and the chair of the National Association of Personal Financial Advisors.
Michael D. Gibney, a certified financial planner and principal with Modera Wealth Management in New York, said that while rates on the lines were less appealing than the 3 or 4 percent available several years ago, they were likely to fall if the Federal Reserve continued to cut interest rates as anticipated. Mr. Gibney said that he took out a HELOC over the summer at 8.9 percent, but that the rate fell to 8.4 percent after the Fed’s rate cut in September.
If you plan to use HELOC as backup emergency financing, check to see if the lender has a minimum draw requirement or charges fees for “inactive” accounts, Mr. McBride of Bankrate advised.
Here are some questions and answers about home equity borrowing:
What are current interest rates on HELOCs?
The average rate for HELOCs was 8.69 percent as of Oct. 16, compared with about 9 percent a year ago, according to Bankrate.
As with any type of borrowing, the rate you qualify for will depend on factors like your credit score and how much debt you already have. Ms. Alt advised shopping around to get the best rate, starting with your own mortgage lender since it’s familiar with your history.
Some lenders offer a lower, introductory rate for six months to a year, after which the rate can change based on prevailing interest rates. Bank of America, for instance, is currently offering home equity lines of credit that start at about 6.7 percent for six months and then rise to about 9 percent, though details vary by market.
Is the interest on home equity financing tax deductible?
It’s deductible up to certain limits if you use the money on home repairs or upgrades and itemize deductions on your tax return. If you use the funds for other purposes, like buying a car or taking a vacation, it’s not deductible. Check Internal Revenue Service rules for details. (And note that they may change after 2025, when tax changes enacted in 2017 are set to expire).
What if I prefer a fixed-rate loan?
Home equity loans also allow you to tap value in your home by taking out a lump sum at a fixed interest rate and paying in monthly installments, typically over a term of 10 or 15 years. The average rate for home equity loans was 8.36 percent as of Oct. 16, down from 8.86 percent a year ago, Bankrate reported.
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