If you’re thinking of using a home equity line of credit – a HELOC – to save your finances during the COVID-19 pandemic you might want to proceed with caution. What’s happening in the market is likely to surprise a lot of homeowners. The basics look like this:
- American homeowners have never had more real estate equity, and it’s worth trillions of dollars.
- But it’s difficult to get new HELOC financing as lenders pull back.
- If you have a HELOC firmly in place and real estate values go down or your financial standing changes, federal guidelines allow lenders to stop HELOC withdrawals even if your payments are current.
- The good news? There are some alternatives for homeowners quickly get needed cash.
Trillions in real estate equity beyond reach
American homeowners are sitting on huge amounts of tappable equity. According to Black Knight, tappable equity – the amount available to homeowners with mortgages to borrow against before reaching a maximum combined loan-to-value ratio of 80 percent – rose 8 percent annually in the first quarter of the year to an all-time high of $6.5 trillion.
Despite the vast amount of equity held by US homeowners relatively little of it has been converted into spendable cash. The Urban Institute estimates that home equity loans represent just 4.4 percent of total US equity. Equifax reported that for the week of June 21 no more than 270 HELOCs were originated nationwide. A year earlier 27,620 HELOCs were originated during the same period.
That’s on the order of a 99 percent reduction in originations of these loans. The reality is that HELOC financing is exceedingly difficult to get.
When the need for cash is greatest, HELOCs shrink
With more than 45 million unemployment applications in just a few months, there’s no shortage of people who would like to have more cash. Some of the downturn has been offset with government programs such as $1,200 Treasury checks and an extra $600 a week for those collecting unemployment, but both efforts have their limitations. There might be another round of Treasury checks or, given the divisiveness on Capitol Hill, maybe not. As to that extra $600 per week for the unemployed, that program is scheduled to end July 31.
For many homeowners a HELOC is especially attractive. Essentially a credit card secured by real estate, HELOCs tend to have small upfront costs and lots of convenience. With a 20-year HELOC a borrower might have 10 years to both draw money from the line and to pay it down. After the draw period ends, the borrower then repays any outstanding debt over the next 10 years and generally isn’t able to make further draws on the credit line.
Lenders traditionally like to extend HELOCs. They’re a secured form of debt and usually come with a variable interest rate. As this is written, qualified borrowers with good credit can get 30-year fixed-rate first-mortgage financing at 3.31 percent while HELOC rates range from 2.87 percent to 21 percent, depending on your credit.
In normal times the combination of low interest rates and rising home values would elate mortgage lenders. But these aren’t normal times. The COVID-19 economy is here and lenders are necessarily re-thinking the usual notions of risk.
The issue with HELOCs is that they’re traditionally second loans. That’s not usually much of a concern for lenders because with rising home values and declining loan balances real estate equity is generally going up. More equity is a protection for lenders if things go wrong. If borrowers do not pay their loans and a home must be foreclosed then lenders are likely to get back all of their money from homes with lots of equity.
But if home values stall or fall — as they did during the mortgage meltdown of 2008-2009 — then things are different. In a foreclosure the lender with the first loan must be completely paid off before a lender with the second loan gets a dime. If prices drop, second-loan lenders suddenly have a lot more risk. A massive wave of unemployment magnifies that risk.
Home prices are generally rising at this moment but it’s anybody’s guess what the future holds, especially as the pandemic drags on. Mortgages issued today typically remain outstanding for years, even decades.
For many lenders, the origination of second-loan HELOCs represents just too much risk in a changing economy for the amount of profit involved. It’s just that simple.
An existing HELOC is not a sure source of emergency cash
If you have a HELOC and you’re in the draw phase, can you be sure that such financing is a ready source of cash?
Experience from the mortgage meltdown suggests that further HELOC withdrawals are not a sure thing. Rules issued by the Federal Deposit Insurance Corporation back during the mortgage crisis of 2008-2009 allow lenders to cut these lines, based on certain criteria.
The FDIC outlined several conditions under which lenders can elect to suspend further HELOC withdrawals, such as when the value of the dwelling that secures the loan declines significantly below appraised value. Lenders are not required to obtain an appraisal to show that the value of an individual home has been reduced.
If the lender has a ‘reasonable belief’ that the consumer will not be able to meet his or her repayment obligations, the credit line can also be cut or ended. A lender may — but need not –– rely on specific evidence, such as a failure to pay other debts, to conclude that a consumer will not be able to repay the HELOC.
The bottom line is your lender can pull the line of credit just when you might need it most, such as when you can’t pay your bills due to a loss of income or a medical emergency that won’t allow you to work.
You might consider drawing out your home equity just in case, but that has its drawbacks as well.
“Tapping a home equity line of credit means adding another monthly payment to an already tight household budget. While this could be a way to tide you over short-term, whatever is borrowed must eventually be repaid with interest. Your home is collateral, so tread carefully,” said Greg McBride, Bankrate’s chief financial analyst. “If you lose a job or suffer an income reduction, seek payment relief on your existing obligations – mortgage, car loans, credit cards. This can better help you stretch the limited dollars coming in or sustain your savings a bit longer.”
HELOC alternatives to get cash
There are other options to get cash you may want to consider:
- Get a home equity loan, really a second mortgage where the borrower receives all funds at closing. These may be easier to obtain than revolving lines of credit.
- If you’re age 62 or above consider a reverse mortgage.
- Use cash-out refinancing and replace your existing first mortgage with a new and larger loan.
- Sell the property and move to a less-expensive community where mortgage costs are lower and you may be able to keep some cash from your the sale of your old home.
- Sell your house, pocket the cash, and rent.
- Get a zero-interest credit card that has an introductory interest-free period.
- Unsecured personal loans may also be available, although interest rates are much higher than home-secured loans.
To be sure, lenders are still extending mortgages. For the week of July 3, the Mortgage Bankers Association said refinancing activity rose 111 percent compared with a year earlier. while purchase money mortgage originations increased 33 percent.
If you have equity and a good borrower profile with strong credit, reasonable debt levels, and solid job security then consider a cash-out refinance instead of a HELOC. A cash-out refinance generally means replacing one first mortgage with another, so lender risk is much lower than with a second loan. A cash-out loan will allow you to refinance your current loan balance at today’s low rates plus acquire additional cash.
Lenders have also cut back on extending cash-out refinances. But they are still more available to homeowners than HELOCs.