The money in our wallets is dwindling. Meanwhile, the value of our homes is skyrocketing. To find out why more and more people are turning to home equity lines of credit (HELOCs) and what they are doing with their home equity, let’s explore HELOCs in greater detail.
Why are HELOCs so popular?
According to the Bureau of Labor Statistics, inflation hit a 40-year high in April, and the Consumer Price Index (CPI) rose to an 8.3% annual increase. The price of essentials such as gas and groceries is increasing, and wages aren’t keeping pace. Not long ago, we might say we felt the pinch of inflation, but today it feels more like a slap across the face.
In times like these, many turn to their home equity for the funds they need. However, traditional refinancing is becoming increasingly less appealing as interest rates continue to climb. Where we saw rates on thirty-year mortgages below 3% a year ago, they surpass 5% today. As the home-buying season slows down toward the end of summer, some predict rates will hit 7%.
Home values are skyrocketing along with interest rates, leading many Americans to turn to a HELOC, instead. Thanks to the rising rates, demand for mortgages has fallen below half of what it was the year before. HELOCs are becoming more and more enticing, however. This growing popularity springs from the fact that they enable you to pull cash from your home without changing the interest rate on your mortgage. Compared to the year before, the popularity of HELOCs surged 31% in 2021’s fourth quarter and 13% in the first quarter of 2022.
Pros and cons of using a HELOC
The popularity of HELOCs is on the rise, but you should be fully informed about these loans before you sign the dotted line. The amount you can borrow with a HELOC depends on your current home equity and your credit score. Generally, you will need to pay off more than 85% of your home’s value before accessing a HELOC. Due to rising home values, you may be sitting on quite a bit more equity than you ever put into your home. That is the good news, but remember, your home is the collateral on this loan, and the consequences are high for defaulting on loan payments.
HELOCs are connected to your mortgage, but they are separate loans. Some people prefer refinancing their entire home instead of taking out multiple liens on their home.
Because it is a second loan and considered riskier by lenders, a HELOC usually comes with a higher interest rate than you would find if you refinanced your entire mortgage. Your interest rate on the HELOC may be higher than the rate on your mortgage, but it is likely to be lower than the rate you will find on a personal loan. On the bright side, HELOCs typically have no fees. You can use as much of the loan as you need and only pay interest on the amount you borrow.
A HELOC will likely have an adjustable interest rate, meaning it may go up over time. For ten years, you will only be paying interest on the amount you borrow. After that time although, be prepared to make payments on the amount you owe, along with interest.
Common reasons for tapping into a HELOC
At one time, the interest you paid on a HELOC was tax-deductible, but legislation has changed those tax benefits. The Tax Cuts and Jobs Act of 2017 prevent you from deducting interest paid on HELOCs through 2026 unless you use the funds to “buy, build or substantially improve the taxpayer’s home that secures the loan.”
Because of the tax deduction, many people opt to take out a HELOC for home repairs. If you go this route, it’s wise to choose home improvements guaranteed to add value to your home. For example, kitchen remodels can substantially boost a home’s selling price, while a backyard swimming pool is not usually a secure investment.
Despite the change in tax benefits, more and more people are accessing the cash in their home equity for various reasons. Because HELOC interest rates are typically lower than credit card debt, many people consolidate high-interest debt by paying it off with a HELOC. This strategy has the double benefit of lowering your interest and boosting your credit score.
Home values aren’t the only thing skyrocketing. With current inflation, many families struggle with mounting healthcare and education costs. People use HELOCs to manage expenses associated with their children’s college tuition, their own student loans, or their parents’ long-term medical fees. A HELOC enables you or your aging parents to access funds when a large tuition payment or medical bill is due and pay the loan down over the following months or years.
Some people also use their HELOC to launch a business. You can invest that money as a down payment on a second home if you have built up equity. You can reaccess the HELOC to improve the property when you pay off the down payment. HELOCs can also provide the capital you need for an entrepreneurial venture. While the HELOC may be easier to obtain and have lower interest than an unsecured loan, remember that your home is collateral for the loan. It will be on the line until you pay back the borrowed amount.
Transforming DEI through Accountability with Dr. Tiffany Brandreth(Opens in a new browser tab)
People often access their HELOCs in an unexpected emergency or to fund a special occasion. Roofs spring leaks, children get married, cars break down, and anniversaries roll around. Life is full of surprises — some good, some bad, and many costly. A HELOC enables you to meet unforeseen expenses without turning to credit cards or exhausting your savings. These are just a few reasons HELOCs are becoming more and more popular.
Discussion about this post