Home equity lines of credit have been declining for more than a decade. But HELOCs are expected to turn around in 2022 as mortgage rates hit their highest levels since 2019.
A home equity line of credit lets you borrow against the equity in your home. You can tap into it periodically and pay off some or all of it, like a credit card. People often use the flexibility of a HELOC to pay for home renovations.
What happened to the HELOCs?
HELOCs had their heyday during the housing boom. Homeowners had 24.2 million HELOC accounts in the first quarter of 2008, according to the Federal Reserve’s Quarterly Household Debt and Credit Report. Eventually, the amount owed on HELOC balances peaked at $710 billion.
Skip to the third quarter of 2021, the latest data, and it looks like HELOCs have gone the way of the landline. The number of accounts (12.8 million) fell by nearly half, and balances ($320 billion) saw a similar decline.
The slow and steady demise of HELOCs began during the housing crisis, as previously inflated home values fell nationwide and lenders shied away from risk. My wife and I saw it with our own eyes. In June 2009, the bank prohibited us from drawing any more on the HELOC that we had opened for half a dozen years, explaining that “the value of your house has gone down again”. My irate wife showed up at the bank branch with a check to settle the balance and close the account.
As home values rebounded in the decade following the housing crisis, homeowners accumulated trillions of dollars in equity. Available equity reached $9.4 trillion in the third quarter of 2021, according to Black Knight, a mortgage technology and data company. Yet HELOCs have yet to make a comeback.
Later homeownership, lower mortgage rates
I wonder if equity lines have faded in part because banks have reduced them as a new generation – millennials – have started buying. If you bought your first home in the last few years, you may not know anyone who has a HELOC. Or maybe your parents had a disheartening experience with a HELOC, like me. If you’re not exposed to HELOC ads, none of your friends have one, or your parents have insulted them, you’re unlikely to get one.
Cynthia Montgomery, director of corporate communications for Truist Bank, disagrees with my theory that millennials despise HELOCs. She says millennials are buying homes later in life than previous generations. “This delay in homeownership has reduced the pool of homeowners who might have considered HELOC for their borrowing needs,” she said by email.
In addition, low mortgage rates pushed equity limits into the background. Record mortgage rates “have prompted many consumers to choose a mortgage refinance over a home equity loan,” Matthew Vernon, head of retail lending for Bank of America, said in an email.
Why HELOCs might bounce
Vernon talks about cash refinancing – a different way to extract equity. While a HELOC is a second mortgage that is towed behind your original mortgage, a cashed-in refi drives alone. It replaces your original mortgage with a loan for more than you currently owe. You receive the difference in cash.
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Cash-in refinances surged in the pandemic era, as the average 30-year fixed-rate mortgage rate remained mostly below 3.5%. But mortgage rates are expected to rise in 2022, potentially approaching 4% by the end of the year. The last time the 30-year fixed rate was consistently above 4% was at the end of 2019.
If your mortgage rate is below 3.5%, you will be hesitant to get a cash refinance as rates approach and exceed 4%. You’ll probably prefer a HELOC instead. A HELOC allows you to maintain the low interest rate on your primary mortgage while converting equity into cash. Rising mortgage rates are why I think HELOCs will become relevant again in 2022.
What could be holding HELOCs back
A resurgence of HELOCs is not a sure thing. HELOC interest rates are variable, not fixed. They are tied to the prime rate, which will increase each time the Federal Reserve raises the federal funds rate. HELOC rates could rise by as much as a full percentage point this year. The prospect of rising interest rates could make some homeowners wary of lines of credit.
Another potential hurdle: shortages of building materials and skilled workers could force home renovations to be postponed, delaying the need to borrow.
Deciding between a HELOC and a cash-out refi
You can compare a HELOC with a cash refinance once you have two pieces of information:
- How much money you need for the renovations (or whatever you intend to spend).
- How much you currently owe on your mortgage.
Combine the numbers and use a mortgage refinance calculator to calculate monthly payments at current interest rates. This is your estimated monthly cost for a cash refinance.
To estimate minimum monthly payments on a HELOC, go to the Interest-Only Mortgage Calculator and enter the total amount you intend to borrow in the top box, and a $0 down payment in the next box. A typical HELOC has a 10-year interest-only loan term and a fully amortized loan term of 20 years. Rate averages are available on the Current HELOC Rates page.
Combine the estimated HELOC payment with your current mortgage payment. Compare that with the estimated refinance payment.
As mortgage rates continue to rise this year, the scales will increasingly tilt toward HELOCs and away from cash refinances. We will see a revival of HELOCs. Even among millennials.
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