Let’s talk about changing equity levels

Question: With mortgage rates up and home sales down, how much equity have property owners lost in the past few years? What is the best way to access the equity we have?

Answer: Despite a lot of scary headlines, real estate as of this writing has largely held its value since the start of the pandemic. Consider that:

The Federal Reserve reports that between 2020 and mid-2022 real estate equity increased from $33 trillion to $42.1 trillion.

As of November, the National Association of Realtors reports that existing home prices nationwide were actually up 3.5% during the past year.

It is something of a financial miracle that in our pandemic economy home values not only rose, they rose substantially. We don’t know what will happen in the future — and the rest of 2023 is the “future” here — but most homeowners have far more equity at this writing than they had in 2019.

However, while rising equity levels are good news, there is also the reality that interest rates have soared. Weekly mortgage rates went from 3.22% at the start of January 2022 to 6.27% toward the end of December.

There are two bottomline results.

First, while homeowners have more equity, the cost to extract that equity became substantially more expensive in 2022.

Second, as a result of rising rates, mortgage borrowing has fallen through the floor. According to the Mortgage Bankers Association, in late December 2022 weekly refinancing activity was 85% lower than a year earlier while purchase loan originations were down 36%.

So yes, most homeowners have far more equity than in the past, but accessing that equity is no longer cheap. For those who nevertheless want to borrow against their equity there are several options.

You can replace your current loan with a larger mortgage. However, with higher rates a cash-out refinance is unlikely to make much financial sense because you will lose any lower-cost financing now in place.

Alternatively, you can leave the existing mortgage untouched and get a second loan. This approach preserves the current interest rate and payment on the first loan. However, second loans typically have shorter terms, say 20 years, and that means a larger monthly payment than 30-year financing with the same rate.

Rather than a second loan, another choice is to get a home equity line of credit, a HELOC. This is essentially a giant credit card secured by real estate equity. Generally, such loans have two phases: In the first phase, perhaps 10 years, you can borrow up to the loan limit and pay back. In the second phase, perhaps 10 or 15 years, any unpaid HELOC balance becomes a second loan with regular monthly payments and no more ability to withdraw funds.

You might also consider an ARM — an adjustable-rate mortgage. This is a loan where the initial rate is set for several years, say five, and then it moves up or down each year. The initial rate is pegged below the current fixed-rate level, but it is possible that in time the rate might go higher. The borrower’s real bet is that monthly costs will stay low because when the rate changes several years will have passed, so there is less debt and that can help keep payments low.

Speak with loan officers for details and specifics. Ask about interest rates as well as fees and charges and how much cash you will pay out during the first five years of the loan term.