Is the bloom off the home equity rose?

Tapping their home equity for cash has been incredibly popular for homeowners in the last few years. That’s partly because they’ve got a lot of equity to tap — particularly since the pandemic: As home prices have soared, so has the worth of ownership stakes. U.S. mortgage-holding homeowners collectively have $10.6 trillion in tappable equity. That translates into nearly $290,000 per homeowner.

Also, starting in mid-2022, the rise in mortgage rates made home equity loans and home equity lines of credit (HELOCs) a more viable option than cash-out refinances. That’s because many borrowers’ primary mortgages were locked in at historically low rates; rather than surrender a 3 percent loan in a refi, second liens made more financial sense.

But interest-rate inflation has caught up to home equity. The week of Nov. 8, the average rate on a HELOC topped 10 percent — an over 6 percent increase since March, 2022 — and it’s stayed above this mark since, according to Bankrate’s survey of the nation’s largest lenders. Home equity loans are high, too, sitting above 9 percent. “If you are going to borrow from your home equity, understand that you’re doing so at a time when the cost of that borrowing is the highest in more than 20 years, if ever,” warns Greg McBride, Bankrate’s chief financial analyst.

So, are home equity loans still a good idea? Let’s crunch some numbers and see.

Home Equity
Despite high rates, a recent survey by TD Bank found that 57 percent of respondents who previously or never had a HELOC or home equity loan said they are likely to apply for one in the next 18 months, up from 9 percent 2022.

Why home equity loans and HELOCs are rising

First, what’s behind the roller-coaster ride in home equity rates? “We’ve been in a quite unusual environment over the past few years ultimately harkening back to a short, but severe recession related to COVID-19 pandemic lockdowns,” explains Mark Hamrick, Bankrate’s Senior Economic Analyst.

During the pandemic, interest rates plunged to historic lows: Hovering in the 4-to-5 percent range, home equity loans and home equity lines of credit (HELOCs) were incredibly affordable. But when the Fed began raising its benchmark interest rate in mid-2002, in its efforts to curb inflation, home equity products began to follow suit.

Home equity loan and HELOC rates have also bounced around in relation to each other. Prior to the pandemic, HELOC rates were higher than home equity loan rates. But Bankrate’s rate survey data shows that, in early 2020, HELOCs became more affordable for a period of over two years. Then, rates between the two products were comparable, until early this month. Now, HELOC rates are above home equity loan rates by almost a full percent.

These variances in rates are in part due to the indices that the rates are tied to. “HELOCs are short-term, akin to CD rates,” says Lawrence Yun, NAR’s chief economist. “In contrast, home equity loans are tied to longer-term rates, and commonly used for major expenditures like remodeling.”

As of early December, here’s where the average home equity loan and HELOC rates stand:

HELOC 10-year home equity loan 15-year home equity loan
10.03% 9.07% 9.11%

How rising interest rates have impacted home equity borrowers

Currently, the average home equity loan rate average ranges from 7.95 percent to 10.73 percent, depending on the loan terms and your finances, according to Bankrate’s survey of the nation’s largest lenders. However, just three years ago, these averages were closer to 5.50 – 6 percent.

Let’s break down how this rise in rates affects your monthly payment and the total interest you pay. Here’s a table showing the differences for a $50,000 10-year fixed-rate home equity loan, with one at 6 percent and another at 9 percent:

$50,000 10-year home equity loan 6% interest 9% interest
Monthly payment $555 $633
Total interest paid $16,612 $26,005

If you had a 9 percent interest rate, your monthly payment would be $78 more than with a 6 percent rate. And the total interest you would pay over the loan’s lifetime is $26,005 — almost $10,000 more.

Home equity loans may be more difficult to get

Not only do high interest rates make it harder to afford a loan, they also make it more difficult to qualify for one. “As rates have increased, it’s increased the cost of carrying that debt, so the qualifying payment [the amount of income you need for an acceptable debt-to-income (DTI) ratio] has increased and so it has become more difficult,” says Adam Boyd, the Head of Home Equity and Unsecured Lending at Citizens Bank.

Still, if you have good credit and a solid source of income, you may find institutions eager to extend you home equity financing. The rapid rise in mortgage rates means primary loans aren’t financially viable for many and, with many borrowers’ primary mortgages locked in at a low rate, the interest in cash-out refinances (once the go-to equity-tapping option) is pretty low too. So, “you’re seeing a lot of non-bank mortgage companies offering home equity lines as a way to keep business coming in the door,” says Haynie.

Should you get a HELOC or a home equity loan right now?

Despite the increased rates, a home equity loan or a HELOC may still make financial sense, especially if you need the money to make home renovations or repairs. The interest on the loan can be tax-deductible in that case (if you itemize deductions on your tax return). Also, home equity products offer longer repayment terms — as much as 20 years — and lower rates than personal loans and credit cards.

If you have to choose between a HELOC and a home equity loan, there are a few aspects that can make a HELOC more attractive in today’s market:

  • Variable rates: “Borrowers that take a HELOC today will likely benefit from the rate cycle as rates inevitably start to come down,” says Boyd. That means your HELOC rate could drop, whereas, if you have a fixed-rate home equity loan, your rate stays the same.
  • Speed of funding: It can take 45 to 60 days or more for a home equity loan to close. “With many lines [of credit], we’re able to originate in two weeks or less,” Boyd says. He adds that this speed is not uniform among lenders, so ask about funding time when shopping for a loan.
  • Flexibility: HELOCs offer a more adaptable approach. “You have the ability to draw down on it and use it for whatever you were going to use it for, then you can pay it back like a credit card,” says Ron Haynie, the Senior Vice President of Housing Finance Policy for the Independent Community Bankers of America. “Most HELOCs, you’re paying interest-only during the draw period,” he adds. With a home equity loan, you’re getting a lump sum and start paying it back in full immediately.

Still, “fixed-rate home equity loans are good if you have a specific purpose,” Haynie says — or a specific sum you know you need, like to pay off all outstanding credit card balances. And the loans do have lower interest rates right now than HELOCs.

‘Be careful’

Of course, home equity products come with caveats too — and this high-rate environment only intensifies the risk. For starters, they use your house as collateral. “Home equity loans and HELOCs are tied to your home, so if you can’t make payments you’re at risk of losing your house,” says Chloe Moore, a Certified Financial Planner and founder of Financial Staples, a virtual, fee-only financial planning firm. This can also put you in a financial bind if home prices drop significantly: In between your first and second mortgages, you could owe more money than what your home is worth.

“Consider why you’re wanting to use your home equity,” Moore adds. “If it’s for a home renovation project, could it wait? If you’re consolidating debt, do you have a solid plan to repay the loan and ensure you don’t incur more debt over time? Are you at risk for being laid off, and if so, do you have an emergency fund to cover a loss of income?” All of these things need to be carefully considered before depleting an equity stake.

In short, “be careful,” says Haynie. “Use your equity wisely and make sure that the reason for you tapping this equity is a good reason.”

If you are going to borrow from your home equity, understand … the cost of that borrowing is the highest in more than 20 years. — Greg McBride, Bankrate Chief Financial Analyst

Alternatives to HELOCs and home equity loans

Personal loans

Instead of tapping into your home equity, you could consider getting an unsecured personal loan. They aren’t tied to your home, so you don’t risk losing it if you can’t repay the loan. They’re also convenient and quick, with funding coming in as soon as one day.

“That typically comes at a higher cost,” Boyd says. “The average rate you get on a personal loan is generally going to be higher than what you can get on a home-secured product.” For instance, as of Dec. 4, the average rate of an unsecured personal loan is 11.53 percent. Compared that to a HELOC at 10.03 percent and a 10-year home equity loan 9.07 percent.

Unsecured personal loans also don’t generally allow you to borrow as much. “Unless you’re in a very good financial situation, you’re not going to get the amount of the credit line unsecured,” Haynie says. “Most people aren’t going to get $50,000 or $100,000.”

Home Equity
For those with exceptional credit and high income, there are lenders that offer unsecured personal loans for $100,000 or more.

However, a personal loan could be the right option, especially if you aren’t borrowing a lot. “If you have really good credit and you’re borrowing $15,000 or $20,000, the personal loan might be the better route to go,” says McBride.

Cash-out refinance

A cash-out refinance could be another option. Refinance rates remain lower than home equity loan rates and may not be that bad a deal, depending on how old your primary mortgage is, and how sizable your ownership stake.

For instance, say you are halfway through your 30-year loan term, owe $50,000 on a home valued at $400,000 and your current mortgage rate is 6 percent (the average 30-year-fixed mortgage rate back in 2008). At today’s rates, you can get a 15-year cash-out refinance for 6.78 percent and pull out $80,000 in equity. So, it may make more sense for you to refinance than to take out a home equity loan or HELOC at a significantly higher rate.

Bottom line on home equity loans today

Proceed with caution before getting a HELOC or home equity loan right now. “Look at what options you may have, including not doing it,” says McBride. “If you do borrow, you’ve got to have a firm plan for paying it back.”

Not all borrowers have the option to wait for rates to drop, however. For instance, your home may need significant repairs or remodel work sooner rather than later. Or you’d really like to clear that credit card debt once and for all.

If you’re trying to tap your home equity right now, compare a variety of lenders and products. These rates change frequently and can vary significantly depending on the lender and your financial profile.

Also, “as you do research, don’t just focus on the advertised rate,” Adam Boyd advises. “Talk with the lender and understand what the other stipulations are attached to that rate just to make sure you’re considering all costs associated with the loan.” This way, you can better choose the right home equity product for you — whether it’s now or in the future.