New homes being built by CastleRock Communities in Kyle, Texas in November 2021.
Matthew Busch | Bloomberg | Getty Images
Record house price increases are also increasing the amount of equity people have in their homes.
For many Americans, this means they can borrow more against what is often their biggest asset.
However, financial experts advise you to think carefully before taking such a step.
The average mortgage holder currently has approximately $185,000 in real estate capital to operate, which is the amount they can access while maintaining a 20% stake, according to Black Knight Mortgage Research.
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Homeowners’ net worth now stands at $9.9 trillion, according to Black Knight. It comes after a 35% gain in 2021 worth $2.6 trillion, the largest annual increase on record, beating a $1.1 trillion rise in 2020.
For some owners, the strength of the market has made it an attractive time to sell. Of course, those same rising prices, along with high rents, can make it difficult for people to relocate.
Many homeowners have instead opted to withdraw cash from their home, which they can traditionally do in three ways. This includes what is known as cash refinancing; home equity lines of credit, or HELOCs; and reverse mortgages, often offered through what are called home equity conversion mortgages, or HECMs.
More and more homeowners, especially those aged 62 and over, have been keen to extract equity from their homes under current market conditions, Urban Institute research found. The combined number of such senior loans rose to 759,000 in 2020 from 647,000 in 2018.
This increase is mainly due to cash refinances, where a new, larger mortgage replaces the previous one. The median loan for these deals rose to $205,000 in 2020 from $180,000 in 2018, according to the Urban Institute.
With borrowing costs expected to rise as the Federal Reserve raises interest rates, this could incentivize homeowners to make these trades now.
“As interest rates rise over the coming year, you might see people using more second-tier products … to tap into some of that equity when they need it,” Karan Kaul said. , senior research associate at the Urban Institute’s Housing Finance Policy Center.
“People already have a very low rate, and as rates go up, it won’t be economical for most of them to refinance,” Kaul said.
As rates rise, the market could shift from mostly cash-in refinance transactions to more HELOCs and home equity loans in the coming years, he said.
Cash refinances require you to refinance your entire mortgage, which may not be economical for many consumers because their payments would likely increase. A HELOC may be a better option for someone renovating their bathroom, for example, who only needs to borrow $25,000. While this may have a higher interest rate, the underlying principal of this loan is much lower, Kaul said.
“It’s an individualized, personalized calculation that has to be done at the household level,” Kaul said.
When deciding to borrow from your home, it’s important to remember that lenders will typically want you to retain a 20% equity stake, said Greg McBride, chief financial analyst at Bankrate.com.
“Overall, it’s not 2005, when you can withdraw every penny of capital you have,” McBride said.
“Just because you have equity in your home doesn’t mean you can borrow,” he said.
For people who want to withdraw cash to pay off their credit cards or fund home improvement projects, the temptation can always be great.
Current credit card rates hover around 16%, according to Bankrate, while mortgage rates hover around 4%.
McBride cautions against consolidating your credit card debt with a home equity loan as a permanent solution. If the debt is the result of a one-time event, like a medical bill or a period of unemployment, this can be helpful. But if that’s indicative of your lifestyle, chances are you’re still building up a balance on a home equity loan.
“If you haven’t fixed the problem causing the credit card debt, you’re just moving around the deck chairs on the Titanic,” McBride said.
Aleksandarnakic | E+ | Getty Images
Home improvement projects can also be a reason to tap into the equity in your home.
“If I add another bedroom, bathroom and pool, the value of that is instantly more than you can buy, not to mention the fun you’ll get along the way,” said Charles Sachs, a certified financial planner. and Chief Investment Officer at Kaufman Rossin Wealth in Miami.
Although some of Sachs’ wealthy clients have pursued these transactions to improve their homes or even invest in higher-yielding investments, these strategies aren’t for everyone, he cautions.
You need to be financially savvy and have the ability to take risks, he said.
Moreover, it is impossible to know when the absolute trough for borrowing will be. Yet we can look back five years and be envious of today’s interest rates, he said.