If you’re a homeowner, you could qualify for a unique financial product: the Home Equity Line of Credit (HELOC). HELOCs allow you to borrow money against the equity you have in your home and similar to a credit card, they offer a revolving credit line that you can tap into as needed.
“Equity is the market value of your home less what you owe on your mortgage balance,” explains David Lopez, a Philadelphia-based member of the American Institute of Certified Public Accountant’s Financial Literacy Commission.
With home values on the rise and interest rates historically low, HELOCs are an attractive option right now. Plus, according to Lopez, for most borrowers, there’s the added benefit of a potential tax deduction on the interest you pay back.
However, since your home is on the hook if you can’t meet your debt obligations, you’ll have to be cautious, explains David Reiss, a professor at Brooklyn Law School and editor of REFin blog, which covers the real estate industry.
So, what are the most common reasons you might consider leveraging this tool? According to the Novantas 2015 Home Equity Survey, 50 percent of people said they opened a HELOC to finance home renovations, upgrades and repairs.
That was the case for Laura Beck, who along with her husband, used their equity to fund a substantial home renovation that doubled their square footage and home’s value.”The HELOC let us do a full renovation right down to re-landscaping the yard without being nervous about every penny spent,” she says.
Interested? Here are a few of the most common reasons people leverage a HELOC:
Home improvement expenses
Upgrades to your home can increase the market value and not to mention, allow you to enjoy a house that is customized to fit your family’s needs.
Pro Tip: Some improvements and energy efficient upgrades, such as solar panels or new windows may also score you a bonus tax credit, says Lopez.
Exchanging high interest debt (like credit cards) for a lower interest rate makes sense, especially since interest payments on your HELOC are usually tax deductible, says Lopez.
Pro Tip: Reiss stresses how important it is to “be cautious about converting unsecured personal debt into secured home equity debt unless you are fully committed to not running up new balances.”
When faced with a situation in which money is the only thing preventing you from getting the best medical care, a HELOC can be a literal life saver, Reiss explains.
Pro Tip: If you need to pay an existing medical bill, however, try negotiating with the health care provider rather than use your equity, says Reiss. Often, they are willing to work something out with you, and you won’t have to risk your house.
Reiss explains how a good education can improve one’s career outlook, increase earnings, and has the potential of offering a strong return on your investment.
Pro Tip: Before turning to your equity for education costs, try to maximize other forms of financial aid like scholarships, grants, and subsidized loans.
No matter your reason for considering a HELOC, if used responsibly it can be a great tool, says Reiss. For information on how to qualify, speak to a banking professional to see if this is a good option for you.
Alicia Johnson and her husband wanted to renovate their home last fall but ran into a roadblock: When they tried to refinance their mortgage and borrow against their equity, five banks said no.
Problem was, the Johnsons’ mortgage covered their home in Christiansburg, Va., and some adjacent land — a deal-breaker.
“They all pointed to the same thing: The rules have changed,” she said. The banks refused to lend against both the home and the land.
Their frustration reflects a major factor slowing a still-sluggish U.S. economy: The inability of many to tap their home equity.
Americans have long borrowed against the ownership stakes in their homes to buy cars, build decks and renovate houses. That borrowing helped accelerate consumer spending, the U.S. economy’s primary fuel — until the housing bust struck a decade ago and shrank home prices.
But prices have recovered, and housing equity now equals 58% of home values — the highest point since 2006. Yet borrowing against that equity has barely budged from post-recession lows, which helps explain why consumer spending remains weak eight years after the Great Recession ended.
The main problem, according to consumer surveys and banking analysts, is that despite low interest rates, it has become harder to borrow. The web of lending regulations that was tightened after the financial crisis has yet to be eased. Many households would like to borrow more through home equity credit lines or cash-outs from loan refinancings. But having been burned by defaults during the financial crisis, banks are demanding nearly pristine credit.
“It’s harder to do a cash-out refinancing or get a home equity line of credit than it used to be,” said Karen Dynan, who was a chief economist at the Treasury Department in the Obama administration. “That has dampened the housing wealth effect” — the tendency of households to spend more when home values rise.
Johnson, 54, had hoped to spend $30,000 on the renovation. It would have meant building a music studio and adding wheelchair ramps and other modifications for her husband, a disabled veteran. That project is now on hold.
Americans do carry slightly more overall debt than before the recession, according to data from the Federal Reserve Bank of New York. But that’s mainly because of huge increases in student loans. By contrast, the kind of debt that fuels consumption — credit card borrowing as well as housing debt — remains well below pre-recession peaks.
Research from the New York Fed suggests that if home-equity-related borrowing were to regain healthier levels — dating to the early 2000s, before the housing bubble — the economy could accelerate by three-quarters of a percentage point a year.
Stricter lending rules aren’t the only factor restraining borrowing. Younger and less affluent Americans are less likely than before the recession to own a home, for example, or to have much equity to borrow against if they do own. These are people who have historically been most inclined to borrow and spend.
Older, wealthier homeowners now own a larger share of America’s housing wealth. Yet at their age, they’re less likely to borrow for big purchases or projects.
Partly as a result, Americans have increased spending an average of just 2.3% a year since 2009, when the recession ended, just two-thirds of the historical norm. Because consumer spending drives about 70% of the economy, that weaker pace has hobbled growth.
The economy hasn’t grown 3% or more — its long-term norm — for a full year since 2005. Other factors are also slowing the economy, like retirements by the vast generation of Baby Boomers. But weak consumer spending is a significant drag.
“The previous behavior of using housing debt to finance other kinds of consumption seems to have completely disappeared,” William Dudley, president of the New York Fed, said in a speech earlier this year. “People are apparently leaving the wealth generated by rising home prices ‘locked up’ in their homes.”
Americans borrowed an average of $181 billion annually against homes from 2000 through 2003, before the reckless borrowing of the housing bubble, New York Fed economists found. But from 2012 through 2015, as housing recovered, they borrowed just $21 billion annually on average.
Banks now must hold more money in reserve for each home equity credit line they extend. So home equity lines have become a less attractive business for banks than loans that require lower reserves.
Mortgage buyers Fannie Mae and Freddie Mac can now send home loans that default back to the banks that provided them, thereby inflicting losses on the banks. Fannie and Freddie also view cash-out refinances as riskier now and have imposed higher fees to guarantee them. This makes such loans costlier for banks and consumers.
Banks are increasingly focusing on the most credit-worthy borrowers. It now requires an average credit score of 780 to get a home equity loan, up from 730 before the housing bust, the New York Fed estimates. Barely 30% of households have scores that high.
“There’s been a really striking shift, with a whole class of scores that are no longer getting loans,” said Bill Nelson, deputy chief economist at The Clearing House, a banking trade group.
The use of homeownership debt can be healthy, Dudley noted. Most people earn more as they age and their careers progress. To borrow against future income, they need to use home equity as collateral.
“I called to ask questions about accessing the equity in my home to help me cover my monthly expenses, but my son was not in favor of it. Of course, he doesn’t live with me, and he doesn’t pay my bills. He just thought it was a bad idea. I asked him to talk to my loan officer who was able to meet all of his objections. I am so glad that I didn’t just stop when my son said he didn’t like it!”
This scenario is repeated daily as well-meaning children, who are not updated on the important changes that the US Government has put into place in recent years to make home equity loans safe for senior borrowers, prevent their parents from moving forward with a transaction that would truly benefit them. Misinformation about reverse mortgages abounds, and so it is necessary to ask the tough questions and get accurate information.
The first objection that is often made is, “Mom, the bank will own your home!” Actually, that is not true. Mom never gives up title to her home.
“But Dad, there will be no inheritance for us kids!” This sometimes comes from children who do not realize that the property can be willed to the heirs. With the government safeguards now in place, the heirs can refinance for 95% of the appraised value, or sell the home as they choose, no matter the out-standing balance of the equity loan when their parents pass away. Since the federal government insures a reverse mortgage, no one will ever owe more than the value of the home. Once the mortgage is satisfied, the heirs will receive the additional proceeds from the sale, if they have not refinanced.
Many times seniors have worked all their lives to provide for their families. They have made hard choices, and paid off the mortgage on their home. Rather than struggling to have funds to pay the bills in retirement, they can now unlock the equity in their home, and provide for a more secure financial life in their golden years.
Contact your local Reverse Mortgage Specialist for additional information that will help you make a wise choice for financial security in your retirement.