Liz Weston: Should you be tapping into your home equity when home values are rising?
Soaring home values mean many homeowners are awash with equity — the difference between what they owe and the value of their homes. The average home price is up 42% since the pandemic began, and the average homeowner with a mortgage can now tap into over $207,000 in equity, according to Black Knight Inc., a mortgage and real estate data analytics company.
Spending that fortune can be tempting. Proceeds from a home equity loan or line of credit can fund home renovations, college tuition, debt consolidation, new cars, vacations — whatever the borrower wants.
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Of course, just because something can be done doesn’t mean it should be done. One risk of borrowing like this should be pretty obvious: you’re putting your home at risk. If you can’t make the payments, the lender could force you out of your home.
As we learned during the Great Recession of 2008-2009, house prices can go down as well as up. According to a 2011 report by CoreLogic, a real estate data company.
Other risks are less obvious but worth considering.
YOU MAY NEED YOUR EQUITY LATER
Many Americans are not saving enough for retirement and may need to use their home equity to avoid a sharp decline in their standard of living. Some do this by selling and downsizing their homes, freeing up money to invest or to supplement other retirement income.
Other retirees may be turning to reverse mortgages. The most common type of reverse mortgage allows homeowners over the age of 62 to convert home equity into an amount of money, a series of monthly payments, or a line of credit that they can use as needed. The borrower does not have to repay the loan while living in the home, but the balance must be repaid if the borrower dies, sells, or moves out.
Another potential use for home ownership is to fund a nursing home or other long-term care facility. A semi-private room in a nursing home costs an average of $7,908 per month in 2021, according to Genworth, which offers long-term care insurance. Some people who don’t have long-term care insurance instead plan to borrow against their home equity to pay those bills.
Of course, the more you owe on your home, the less equity you have for other uses. In fact, a large mortgage could put you off getting a reverse mortgage in the first place. To qualify, you must either own your home outright or have a significant amount of equity – at least 50% and maybe more.
YOU ARE IN DEBT
Using your home equity to pay off much higher-interest-bearing debt, such as Credit cards, for example, can seem like a smart move. Finally, home equity loans and lines of credit usually have much lower interest rates.
However, when you file for bankruptcy, your unsecured debts — like credit cards, personal loans, and medical bills — are usually erased. Debts secured by your home, such as B. Mortgage and home equity loans, these are usually not.
Before you use home equity to consolidate other debt, you should consult with a nonprofit credit counseling agency and a bankruptcy attorney about your options.
WHAT YOU BUY WILL NOT SURVIVE THE DEBT
It’s rarely, if ever, a good idea to borrow money for pure consumption like vacations or electronics. Ideally, we should only borrow money for purchases that increase our wealth: for example, a mortgage to buy a house that will be appreciated, or a student loan that will result in a higher lifetime income.
If you’re planning to borrow a home to pay for something that won’t appreciate in value, at least make sure you don’t make any payments long after the useful life has expired. If you’re using home equity to buy a vehicle, consider limiting the loan term to five years so you don’t face high repair bills while you pay off the loan.
Home equity loans typically have fixed interest rates and fixed terms ranging from five to 30 years. The typical home equity line of credit, meanwhile, has variable rates and a 30-year term: a 10-year “drawing period” in which you can borrow money, followed by a 20-year payback period. Typically, you only have to pay interest on your debt during the drawing period, which means your payments could increase significantly at the 10-year mark when you start paying back principal.
This leads to one final piece of advice: as interest rates rise, only consider using a HELOC if you can repay the balance fairly quickly. If it takes you a few years to pay back what you borrowed, a fixed rate home equity loan might be a better way to tap into equity now.
This column was provided to The Associated Press by personal finance website NerdWallet. Liz Weston is a columnist at NerdWallet, a certified financial planner and the author of Your Credit Score. Email: [email protected] Twitter: @lizweston.