Mortgage holders have an average record of $185,000 in equity. What to know if you’re tempted to borrow from that

The amount of equity people have in their homes is increasing as home values reach new highs. For many Americans, this means being able to borrow more against their most valuable asset. However, financial experts advise that you consider twice before making such a decision.

According to Black Knight mortgage research, the average mortgage holder has around $185,000 in home equity to tap, which is the amount they can access while still maintaining a 20% equity.

Total homeowner equity has reached $9.9 trillion, according to Black Knight. This follows a 35 percent growth of $2.6 trillion in 2021, the highest yearly increase on record, surpassing a $1.1 trillion increase in 2020.

The rising market has made it an appealing moment to sell for some homeowners. Those same rising prices, as well as high rents, might make it harder for people to move.

Instead, many homeowners have elected to borrow money from their homes, which they can do in one of three ways. Cash-out refinancing, home equity lines of credit (HELOCs), and reverse mortgages, which are typically given through home equity conversion mortgages, or HECMs, are all examples of this.

According to research from the Urban Institute, more homeowners, particularly those aged 62 and up, are keen to extract equity from their homes in light of current market conditions. From 647,000 in 2018, the total number of senior loans grew to 759,000 in 2020.

Cash-out refinances, in which a new, larger mortgage replaces the prior one, accounted for the majority of the increase. According to the Urban Institute, the median loan for those deals increased to $205,000 in 2020 from $180,000 in 2018.

Because borrowing costs are likely to climb when the Federal Reserve raises interest rates, homeowners may be more motivated to complete these transactions sooner than later.

“As interest rates rise in the coming year, you could see folks using more second lien products … to tap some of that equity when they need it,” said Karan Kaul, principal research associate at the Housing Finance Policy Center at the Urban Institute.

“Folks already have a very low rate, and as rates rise it’s not going to be economical for most of them to refinance,” Kaul said.

As rates rise, he believes the market will shift away from cash-out refinances toward more HELOCs and home equity loans in the coming years.

Cash-out refinances require refinancing your entire mortgage, which may not be feasible for many consumers because their payments will almost certainly increase. Someone who is redoing their bathroom and just wants to borrow $25,000 may find a HELOC to be a better option. While the interest rate on that loan may be higher, the underlying principal is substantially lower, according to Kaul.

“It’s an individualized, personalized calculation that has to happen at the household level,” Kaul explained.

Maintain 20% equity

When considering whether to borrow against your house, keep in mind that lenders normally require a 20% equity investment, according to Greg McBride, chief financial analyst at Bankrate.com.

“By and large, this is not 2005, when you can pull out every last nickel of equity that you have,” McBride said.

“Just because you have home equity doesn’t mean you can borrow from it,” he said.

The temptation for folks who wish to borrow money to pay off credit cards or fund home renovation projects is still present.

Exercise caution consolidating debts

According to Bankrate, credit card rates are currently hovering around 16 percent, while mortgage rates are at 4%.

As a long-term option, McBride advises against merging credit card debts with a home equity loan. It can be beneficial if the debt was incurred as a result of a one-time incident, such as a medical bill or a period of unemployment. However, if it’s indicative of your lifestyle, chances are you will still run up a balance under a home equity loan.

“If you haven’t solved the problem that produced the credit card debt in the first place, you’re just moving around deck chairs on the Titanic,” McBride said.

Consider improving your home

Home improvement initiatives could also be a good reason to borrow against your equity.

“If I add another bedroom and a bathroom and a pool, the value of that is instantly higher than what you can buy for, not to mention the enjoyment that you’ll get along the way,” said Charles Sachs, a certified financial planner and Chief Investment Officer at Kaufman Rossin Wealth in Miami.

While some of Sachs’ high-net-worth clients have used these transactions to enhance their homes or invest in higher-yielding investments, he cautions that these options are not for everyone.

You should be financially savvy and capable of taking risks, he advised.

Furthermore, it is impossible to predict when the absolute lowest point for borrowing will be. Still, we might be envious of current interest rates in five years, he said.

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