More homeowners are tapping a record amount of built-up value

By Moira RitterCoStar News

October 15, 2024 | 5:11 P.M.

After helping his grandson pay his aircraft mechanic school tuition, Jim Hall was struggling to cover all of his own expenses. But instead of adding another small loan to his growing debt, the homeowner decided to try something different: He borrowed from the value of his house.

Now, instead of managing multiple loans, including high-interest credit card debt, the 67-year-old retiree is paying off one loan with a fixed interest rate at about 7% and a set monthly payment.

“I'd kind of been struggling through to just be able to pay his expenses and my expenses being retired on a fixed income,” Hall said in an interview. “So even though the interest rates were kind of high, I thought, well, let me just see what I could do and maybe consolidate some of these things to make sure that I keep everything covered for a little while longer.”

It’s a personal finance strategy that more mortgage holders are turning to at a time when home prices are soaring. Though second mortgages and home equity lines of credit have existed for decades, homeowners are taking greater advantage of these sources of cash given their record-high home equity as a result of more expensive houses.

The approach provides another reason for owners of houses and condominiums to stay in their property, rather than sell and rent an apartment or smaller place to pull cash out. As of the first half of this year, homeowner equity was at a new high, according to St. Louis Federal Reserve data. And based on last year’s borrowing patterns, lenders anticipate that home equity borrowing will expand at least through 2025, according to a Mortgage Bankers Association study.

But industry professionals warn that borrowers will have to find a balance between waiting for an attainable interest rate without waiting until home price growth slows and they need to be disciplined to keep paying down debt to avoid increasing interest costs.

Since the beginning of 2020, the median price of a single-family house in the United States has increased more than 25%, rising from $329,000 to more than $412,000. And in the year ended in July, prices grew 5%, the latest S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index shows.

That rapid increase has pushed equity, the difference between a property's current value and its unpaid mortgage, to new highs. Compared to the same time a year earlier, home equity increased 8% in the second quarter, according to the latest data released by analytics firm CoreLogic. That means the average U.S. homeowner with a mortgage gained about $25,000 in equity over those 12 months. In total, existing equity is about $315,000 for homeowners, up almost $130,000 from before the COVID-19 pandemic, according to the data.

“Given the substantial amount of accumulated equity in real estate, there is still untapped potential for home equity lending for lenders and borrowers,” Marina Walsh, vice president of industry analysis at the Mortgage Bankers Association, said in a statement.

More credit, risk

In 2023, lenders issued $2.13 billion of home equity credit lines and closed-end home equity loans, the industry group said. That’s higher than the previous year, but it's a smaller increase than was recorded in 2022.

But while home equity can offer homeowners a borrowing option that acts as a financial buffer, especially for larger purchases, industry professionals warn it is not an end-all and be-all solution, and it carries significant risk if not used responsibly.

“There’s a lot of pent-up desire, demand for people to pull equity out of their homes,” Melissa Cohn, regional vice president at William Raveis Mortgage, said in an interview. “But it always comes, you know, basically at what cost.”

Home equity loan products can help homeowners consolidate smaller loans — like Hall did — or take out a large loan for bigger expenses by borrowing from the portion of their house they own.

In other words, “you’re transferring the value of the home that you own back to whatever lender holds” the mortgage, Dominic Turano, senior vice president and area manager for lender Atlantic Coast Mortgage, said in an interview.

Borrowers can choose to take a lump-sum loan out of their mortgage, known as a second mortgage, that can be paid back at a fixed or variable rate.

Alternatively, they can opt for an open-ended home equity line of credit, known as a HELOC. They also have the option to refinance their existing mortgage to a lower rate and monthly payment for cash.

Most borrowers take out of their home equity for three reasons: consolidation, home improvement and “cash on hand,” according to Bill Banfield, chief business officer and economist at Rocket Mortgage’s parent company.

Debt consolidation

“There are an enormous number of people, even with good credit, that have a need to consolidate credit card debt, student loans, auto loans, you name it,” he said in an interview. “There’s still a fair amount of home improvement activity that’s occurring. And when those projects are bigger, people often will like to use their equity to make those improvements.”

For Hall, a fixed-rate, lump-sum equity loan — a second mortgage — made the most sense to consolidate his debts and give him the breathing room to make his monthly payments.

Jim Hall, 67, used a home equity loan to help his grandson pay for aircraft mechanic school. (Jim Hall)

After foreclosing on his house in Hawaii, Hall moved to Newport News, Virginia, and spent several years rebuilding his credit. By 2017, he was able to take out a mortgage and purchase a house.

Then, in 2021, when mortgage rate averages plummeted to about 3%, Hall took the opportunity to refinance his mortgage to a lower rate, a move that helped him afford to replace his air conditioning and do some other work to his house. In total, he put about $60,000 of work into the property.

But when Hall’s grandson moved in with him and needed help covering his school tuition and living expenses until he could get a job, things got trickier, and Hall’s loans started to become hard to manage.

That’s when he started working with loan officers to see if a home equity loan would work for him, and he learned that his house purchased for $270,000 seven years ago is now valued at more than $400,000.

“I had equity kind of sitting there, and so I managed to pull off enough money to cover the money that I needed to finish helping my grandson, and then also pay off some of the work I had done around here,” Hall said. “And then that really fit into a nice funds payment that was easier to manage than trying to pay off five different things and wonder, if I’m going to have enough at the end of the month.”

Potential danger

There are drawbacks to borrowing against a home’s value, though. Ultimately, “it’s a tool,” Turano said. “That tool can be used positively, and, depending on the person, that can be used negatively as well.”

For example, borrowers who take out a second mortgage are upping their financial risk should they find themselves in foreclosure. Lenders typically situate a homeowner's first mortgage as the first debt that gets paid off in the event of a foreclosure. If there’s a second mortgage to contend with, that can leave borrowers at risk.

Home equity lines of credit carry risk, too. Turano said he usually tells clients that HELOCs are like a credit card tied to the value they have in their home.

“Just like a credit card, a home equity line of credit comes with an available credit line, and just like a credit card, the more you borrow, the higher the monthly payment’s going to be,” he said in an interview. “Just like a credit card, if you don’t send extra money in on a monthly basis, you’re going to have a really hard time paying that equity line of credit off, which is the polite way to say that you probably never pay it off.”

Even so, for the right borrowers who find themselves in the right financial position to borrow from their home equity, it could be beneficial to move sooner rather than later given macroeconomic conditions.

For one, a borrower who takes out a loan with a variable interest rate today will presumably see that rate ease in the next 18 to 24 months as the Federal Reserve cuts interest rates, according to Turano. At the same time, home prices are expected to climb as mortgage rates fall and more prospective homebuyers come off the sidelines and enter the market. That could give someone who buys today a greater opportunity to build equity in the future.

“My suggestion is typically to go and look to purchase a property now, if you can afford it and it works for your finances in a market where you’re not competing, where you’re not having to make bad decisions about,” Turano said. “And if things hold the way that people expect, and the Federal Reserve continues to lower rates down the line, you have the potential to refinance.”