If you bought your home before you’d ever heard the term “COVID-19,” you’ve probably got an asset worth a lot more than you paid for it.
The price of a home has gone up quite a bit in the past few years – about 20% in the past year – as demographics, remote work, and a strong competition have pushed up demand for houses around the country. That means homeowners are sitting on a lot more equity than you might expect.
You can use the equity in your home in a variety of ways, borrowing against it to get cash you can use for all sorts of things. The question is, is it wise to treat your house like a piggy bank?
“There’s going to be the temptation,” says Mark Hinshaw, co-founder and president of Candor Technology, a mortgage tech firm. “They think all of a sudden they’ve hit the lottery.”
Experts say there are ways to prudently borrow against the equity in your home using home equity loans and lines of credit (HELOCs), but that you should be wary of the risks, namely that, like a mortgage, failure to repay could cost you your home.
“This can be money that’s valuable 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 she warns borrowers to be careful about taking out money for non-essentials. “If it’s not a need and it’s just some sort of desire or want, you should really ask yourself: Is this something that is wise?”
Here are some things experts say you should consider before tapping into all that equity.
Homes Are Holding a Lot of Value
Nearly half of mortgaged residential properties in the U.S. were considered “equity-rich” in the first months of 2022, according to the real estate data firm ATTOM. That means the property’s value was more than twice what was owed on all loans secured by it, such as a mortgage.
Property values are up due to the incredibly hot housing market the past couple of years. Ruthless competition for a limited number of available homes means any house that goes on the market has been bound to fetch a higher-than-expected price. There are signs that may be cooling a bit as mortgage rates have risen dramatically since the start of the year, but home prices have yet to decline or even slow down significantly in much of the country.
The fleeting nature of the housing market is one reason to be leery of that windfall of equity, Sherry says.
“Homes go up and down in value,” she says. “I think you have to look at it as if the amount you could sell your house for might go down in the future and you don’t want to borrow too much against it because at closing you’d have to pay back an unusually large sum. You might end up underwater in a really bad scenario, where you would owe back more at closing than you actually were able to sell the house for.”
While homeowners might feel reassured by the idea that they’re “equity-rich,” it isn’t as if their homes are filled to the rafters with $100 bills. Hinshaw compares it to a company owning a lot of assets but not necessarily bringing in that cash in its profit-and-loss statements. “That’s balance sheet rich,” he says. “That’s not P&L rich.”
What Can You Do With Your Home Equity?
The most often-cited way to use a home equity loan is to put that money toward home repair or improvements, whether they’re necessary, like replacing a leaky roof, or big value-adding projects, like a kitchen remodel.
Necessary improvements are logical uses for home equity loans, Sherry says. Repairs or improvements that could raise the value of the home also make sense if you plan to sell shortly. But don’t assume everything will be worth the investment when you go to sell.
“It’s known that certain home improvements don’t bring back as much equity as others do,” Sherry says. “If you were going to spend $40,000 for a new kitchen, would that raise your home’s value by $60,000? Maybe, but maybe not.”
Another popular use for home equity loans and HELOCs is to consolidate higher-interest debt, such as credit card debt and student loans. That can make sense, but be careful, says Vikram Gupta, head of home equity at PNC Bank.
“If you are a homeowner and you have existing debt, using your house to help pay off existing high-cost 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 jeopardizing your house, Sherry says. “Take your highest rate credit card and attack it in a way that you’re going to pay more than what’s required, as much more as you can, and pay it that way rather than borrow against your house,” she says.
For Other Purposes
Some experts say you should consider having a HELOC on hand ahead of any planned home improvements or other big expenses, so you can draw from it if you need to. “If you’re a homeowner, you’re using the smartest capital you can. I don’t like it when people refer to that as consumers using their house as a piggy bank,” says Jim Albertelli, CEO of Voxtur Analytics, a real estate technology company.
Be careful, as that can be “a bit of a temptation for many folks,” Sherry says. “Remember that having that line of credit there doesn’t necessarily mean you should pull on it every five seconds. It should be something you are very disciplined about.”
One important thing to keep in mind is that you need to be able to pay off this debt in the future. “If they’re not confident in their ability to generate cash flows going forward, they should hold off on that,” Hinshaw says. “It doesn’t make sense to be over-leveraged.”
What Are the Risks of Home Equity Loans?
Home equity loans and HELOCs have a lot of advantages over other types of debt, like 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 where you’re using your house, but if used wisely and sensibly it’s a more cost-effective way versus borrowing unsecured,” Gupta says.
Know Your Loan
It’s also important to understand how the loan you’re using works and what the advantages and disadvantages are. Sherry warns against interest-only HELOCs and loans, in which your initial payments only cover interest and don’t reduce the outstanding principal. “You’re going to end up deeper in debt and what they ask you to pay is not going to be enough to wind down the principal that you borrowed,” she says.
Lending Standards Have Changed
Home equity loans played a big role in the financial crisis of the 2000s, as lax lending standards and high housing costs led to people treating their home like an ATM. That isn’t the case anymore, experts say, as regulations imposed in the wake of the crisis mean banks and other lenders are doing their diligence to ensure borrowers can repay.
Going through the paperwork to qualify for a loan can be daunting, but it’s worth the confidence of knowing that you can pay the money back.
“There were no regulations. Lenders were lending very loosely without verifying the borrower’s ability to repay. Customers overborrowed, used their homes as piggy banks,” Gupta says.
One key is to make sure your lender is underwriting the loan – going through your credit history and asking for documents, Sherry says. “You might find it annoying to be asked all these personal questions about your finances, etc., but in the end this is to protect you,” she says. “If you were being provisioned a loan with not many questions asked, that’s a red flag right there.”