Why high interest rates make it difficult to use home equity

Home prices are near historic highs. However, financial advisors say they can be difficult to access due to high interest rates.

Total net worth of US mortgage holders Rose for That will be more than $17 trillion in the first quarter of 2024, just short of the record set in the third quarter of 2023, according to new data from CoreLogic.

Average equity per borrower increased $28,000 to about $305,000 from a year earlier, according to CoreLogic. Chief economist Selma Hepp said the figure was up nearly 70% from $182,000 before the Covid-19 pandemic.

About 60% of homeowners have a mortgage. Their equity is equal to the value of the home minus any outstanding debt. Total net worth of US homeowners with and without mortgages is $34 trillion.

The jump in home values ​​is largely due to rising home prices, Hepp said.

Many people also refinanced their mortgages early in the pandemic when interest rates were “really, really low,” which may have allowed them to pay off their debt faster, she said.

“People who have owned their homes at least four or five years ago are, on paper, feeling fat and happy,” said Lee Baker, founder, owner and president of Apex Financial Services in Atlanta.

But Baker, a certified financial planner and CNBC Advisory Council member, and other financial advisors said accessing that wealth is complicated by the high cost of borrowing.

“Some options that might have been attractive two years ago are not attractive now because interest rates have risen so much,” Camila Elliott, co-founder of Collective Wealth Partners and also a member of the CNBC Advisory Board, told CFP.

However, there may be some cases where it makes sense, according to consultants. Here are some options.

A home equity line of credit, or HELOC, is typically the most common way to use home equity, Hepp said.

A HELOC allows homeowners to borrow against their home equity, usually for a specified period of time. Borrowers pay interest on the outstanding balance.

According to Bankrate data as of June 6, the average HELOC interest rate is 9.2%. Rates are variable, meaning they can change, unlike fixed-rate debt. (Homeowners may also want to consider home loanwhich usually has fixed rates.)

For comparison: rates on a 30-year fixed-rate mortgage. about 7%according to Freddie Mac.

More from the “Personal Finance” section:
Buying a home in the style of Home Alone or John Lennon? Expect a bonus
A 20% down payment is “definitely not required” to buy a home
What to expect from the housing market this year

While HELOC rates are high compared to a conventional mortgage, they are much lower than credit card rates, Elliott said. Credit card holders with an account balance have average interest rate about 23%, according to the Federal Reserve.

Borrowers can usually press up to 85% on the value of their home minus any outstanding debt, according to Bank of America.

Homeowners can use a HELOC to pay off their outstanding high-interest credit card debt, Elliott said. However, they should have a “very focused plan” to pay off the HELOC as soon as possible, ideally within a year or two, she added.

In other words, don’t just pay the minimum monthly payment on your debt — which can be tempting since those minimum payments will likely be lower than those on a credit card, she said.

Likewise, homeowners who need to make home repairs or improvements can use a HELOC instead of using a credit card, Elliott explained. This could have the added benefit of allowing those who itemize their taxes to deduct the loan interest on their tax returns, she added.

A reverse mortgage it’s a way for older Americans to leverage their net worth.

Like a HELOC, a reverse mortgage is a loan secured against your home equity. However, borrowers do not repay the loan every month: the balance grows over time due to accrued interest and fees.

Reverse mortgages are probably best suited for people who have most of their wealth tied up in their home, advisers say.

“If you are late in retiring [savings]“This is another potential source of retirement income,” Baker said.

A Home Equity Conversion Mortgage (HECM) is most common type reverse mortgage, according to the Consumer Financial Protection Bureau. It is available to homeowners over 62 years of age.

A reverse mortgage is available as a lump sum, line of credit, or monthly payment. It’s a non-recourse loan—as long as you take steps like paying property taxes and maintenance costs and using the home as your primary residence, you can stay in the home for as long as you want.

Borrowers can typically use up to 60% of their home equity.

Homeowners or their heirs will eventually have to repay the loan, usually by selling the home, according to the CFPB.

While a reverse mortgage typically leaves heirs with a smaller portion of the inheritance, it shouldn’t necessarily be considered a financial loss for them: Without a reverse mortgage, those heirs could be paying out of pocket anyway to subsidize the borrower’s retirement income, Elliott said. .

Historically, the biggest benefit of having home equity has been saving more money to invest in a future home, Hepp said.

“This is how people have historically been able to move up the housing ladder,” she said.

But homeowners with a low, fixed-rate mortgage may feel locked into their current home due to the relatively high rates that will accompany a new loan on a new home.

Relocation and downsizing are still possible, but “that math doesn’t really work out in their favor,” Baker said.

“Not only did their house go up in value, but everything else in the neighborhood went up,” he added. “If you’re trying to find something new, there’s not much you can do about it.”

Cash-out refinancing is another option, although it should be considered a last resort, Elliott said.

“I don’t know anyone right now who would recommend a cash-out refinance,” she said.

A cash-out refinance replaces your existing mortgage with a new, larger one. The borrower will receive the difference as a lump sum payment.

Here’s a simple example: Let’s say a borrower has a home worth $500,000 and an outstanding mortgage of $300,000. They can refinance a $400,000 mortgage and get the difference of $100,000 in cash.

Of course, they’ll likely refinance at a higher interest rate, meaning their monthly payments will likely be much higher than their existing mortgage, Elliott said.

“Really crunch the numbers,” Baker said of homeowners’ options. “Because you are cluttering the roof over your head. And that can be a dangerous situation.”