Borrowers wary of loans
Many are refraining from taking out home equity lines of credit
A look at why home equity loans are no longer in vogue, even as property values climb.
For twenty years, Angela Razi thought about owning her own house.
In March, the 55-yearold letter carrier moved into the home she and her husband were finally able to buy: a $175,000 brick ranch in Chicago’s Chatham neighborhood.
And she isn’t going to lose the place by making a mistake in managing her hard-won home equity.
“You don’t want to give up the value you have in your home,” she said. “You don’t want to mess with that.”
Instead of taking out a home-equity loan to add a second bathroom, Razi said she will wait and save money by working overtime. She’s also focused on building her emergency cushion to ensure that house emergencies don’t become financial emergencies.
Even as home equity rockets, homeowners in Chicago and across the country are refraining from taking out home equity loans and lines of credit. Many are gun-shy, recalling the painful recent past, when American homeowners overall lost about a third of their home equity in the real estate meltdown of 2008. The current run-up in property values is also framed by a tenuous period for employment and public health, making borrowers cautious. And some have used pandemic funds to do what financial advisors have recommended all along: build emergency funds that offset the need for ready cash from a home equity line or loan.
Craig Lemoine is director of the financial planning program at the University of Illinois and executive director for the university’s Academy for Home Equity in Financial Planning. He’s also the father of three young children and has no intentions of borrowing against the family house to spend $12,000 for a fancier fence to corral his brood. He and his wife will save for the project, he said.
Home equity loans and lines of credit are not inherently bad, Lemoine said, but they should always be used to accomplish long-term financial goals. “You have to control the faucet,” he said. “If you see it as cheap money and use the loan to consolidate consumer debt, and don’t stop spending, you’ll have heartache again.”
Fast-rising property values have propelled home equity, the difference between what a house is worth and how much the owner still owes on the mortgage. Nationally, homeowners with mortgages had 23% more “tappable equity” in March than they did a year before, according to mortgage data firm Black Knight. Most lenders require homeowners to leave 20% of the equity in their home untouched in case housing values fall, but the average homeowner could now borrow as much as $153,000.
So far this year, houses are worth more than the debt used to buy them, according to Federal Reserve data. The S&P CoreLogic Case-Shiller U.S. National Home Price Index reported on July 27 that home values rose 17% in May 2021 over May 2020.
The more conservative Home Price Index calculated by the Federal Housing Finance Agency reported a 12.5% increase in values nationally, for the 12 months ended in March.
Jody Dabrowski, chief executive officer of the Illinois Educators Credit Union, said that many homeowners used COVID19 stimulus money to both pay down debt and to build up emergency funds. Both moves position homeowners to avoid home equity loans, especially for moderate home repairs and minor emergencies, such as replacing a broken major appliance, she said. The two things
the credit union’s members will borrow against their houses for, said Dabrowski, are home improvement and education.
A 2020 Federal Reserve study found that recreation, trips and child care were the bottom three uses of home equity loan proceeds, debunking the commonly held perception in the wake of the 2008 housing meltdown that homeowners borrow against their home equity for frivolous purposes. Most equity is reinvested in the house through improvements and repairs, the study found. Middle-tier uses include consolidating debt and paying for education and medical expenses.
Taking from the house to spend on the house still makes sense, financial advisors said, but with caveats unique to today’s economy. With labor and materials costs high and unstable, it’s difficult to estimate the return on a home equity project, Lemoine said. And though home values are escalating quickly, financial advisers said it’s smarter to calculate future equity based on a more modest rate of property appreciation.
Add in the unpredictable factor of future interest rates, and the stacked uncertainty explains why homeowners are “skittish,” said Aleksander Tomic, associate dean for strategy, innovation and technology at Boston College.
“If you go with a home equity line of credit, the payments might not be that big now, but if interest rates double, your payments could as much as double,” said Tomic. “Theoretically, you could get into a situation where your HELOC payment is bigger than your mortgage. If rates double from today’s low rates, they’d still be at historic lows, but that would still drive up your payments.”
Financial advisors say that homeowners who do want to integrate borrowing into their financial plans are finding alternatives to home equity loans. After all, pointed out Ron Jahnke, a vice president in the private banking operation of Waukesha Bank in suburban Milwaukee, changes in income tax regulations have erased the value of a mortgage interest deduction for many homeowners.
One common strategy is to refinance the primary mortgage and extract cash out. In June, 42% of homeowners refinancing their mortgages extracted cash, according to Black Knight.
Another, said Jahnke, is to borrow against nonretirement, taxable investment accounts — an option increasingly popular with professionals and business owners who need additional streams of cash flow for their businesses but don’t want to put their houses on the line.
So many lending and home sale regulations and rules have changed in the last decade that even longtime homeowners might want to meet with an advisor who specializes in housing just to brush up on the latest approaches, said Jennifer Fraser, director of stakeholder engagement for Greenpath, a Farmington, Michigan-based nonprofit consumer finance counselor that operates in Chicago and across the country.
“The key is to be educated about the lending products you’re looking at, and measure that against your long-term financial goals,” Fraser said.
Razi talked with Greenpath as she reviewed her finances before applying for a mortgage. She already was aware of the pitfalls of home equity loans, she said, but the agency’s program helped her evaluate whether such a loan made sense for her.
“The economy goes up and down and with the pandemic, I need to be sure I can pay the mortgage,” she said. “I don’t want to get a house and then lose it because I can’t pay the bills.”