American homeowners are flush with equity, but soaring mortgage rates have changed the way they tap that pile of wealth.

In short: Cash-out refinancing is out, and home equity lines of credit (HELOCs) are in.

Homeowner wealth still high

As of mid-2023, American homeowners were sitting on nearly $32 trillion in home equity, according to the Federal Reserve Bank of St. Louis.

Fully 47 percent of mortgaged homes were categorized as “equity-rich” in the third quarter, meaning that the mortgage balance totals no more than half of the home’s estimated market value, real estate data firm ATTOM reports.

Intriguingly, the share of equity-rich homes declined slightly from 49 percent in the second quarter. While the reasons for the decline are unclear, home price appreciation has cooled somewhat, and many homeowners have already tapped their equity for renovations and other expenses.

Better deals and introductory rates

With equity comes opportunity — but with interest rates on the rise, HELOCs have become the better option for many homeowners. These lines of credit come with variable interest rates, which change based on the prime rate, in turn tied to Federal Reserve policy.

The Fed and HELOCs
The Federal Reserve doesn’t directly set HELOC rates, but it does set the benchmark federal funds rate, which lenders use to determine how much you pay. To fight inflation, the central bank boosted this rate beginning in 2022, which drove a sharp rise in HELOC rates. While the Fed has left rates untouched at recent meetings, including its latest gathering on Nov. 1, HELOC rates remain elevated for the time being.

The average HELOC rate was 9.09 percent as of Nov. 1, according to Bankrate’s weekly survey of lenders, up from 9.02 percent the previous week.

While that sounds high, it’s simply an average. The more aggressive home equity lenders win business by dangling generous deals, including lower introductory rates.

In one example, Connexus Credit Union currently markets an introductory rate of just 5.99 percent, three full points below the national average. That HELOC rate stays in place until Oct. 1, 2024, when the rate jumps to 8.74 percent.

Likewise, Central Pacific Bank, which serves customers in Hawaii, currently offers a HELOC introductory rate of 7.85 percent for two years, plus an offer to pay up to $500 in early termination fees if you already have a HELOC with another lender.

Why HELOCs make sense now

Even at 9 percent, HELOCs are still attractively priced compared to unsecured personal loans. If you’re looking to finance a renovation and have equity to tap, a line of credit could be less expensive than a home improvement loan.

A HELOC also spares you from doing a cash-out refinance, which involves replacing your existing mortgage with a whole new loan at today’s rates.

Say you locked in a $300,000 mortgage on your home a few years ago at 3 percent. Your monthly payment for principal and interest would be just $1,265.

Imagine that now you want to tap $50,000 of home equity to renovate your kitchen. When rates were at record lows, the smart move was a cash-out refinance. If you were to borrow $350,000 with a cash-out refi today, you’d have to give up your 3 percent rate for a new rate near 8 percent — and your payment would soar to $2,568.

Here’s a compromise: Keep your 3 percent mortgage, then take out a HELOC for the other $50,000. At 9 percent interest and with a 10-year payback schedule, the debt will cost you $633 a month. Add that to your existing mortgage payment, and it’s still far cheaper than a cash-out refinance.[/media-credit]