Inflation and spiking interest rates continue to plague Americans. The benchmark rate for interest rates now ranges from 5% to 5.25%, a 15-year high. The effect of the Federal Reserve's aggressive rate hike schedule after 10 straight rate increases dating back to March 2022—is mixed. According to March 2023 data from Redfin, home prices nationwide dropped an average of 3.3% compared to a year ago. Meanwhile, the most recent Black Knight Mortgage Monitor report reveals prices are rising in 92% of all markets from February to March, with prices in 40% of major markets returning to peak value.
If you're like most Americans, your home gained value during the pandemic. According to real estate research firm CoreLogic, American homeowners had an average of $270,000 in home equity in late 2022, up $90,000 higher than pre-pandemic values.
If you've got significant equity in your home, you may be able to tap into it to help pay for rising expenses, fund a home improvement project or consolidate debt. Some options, like home equity loans, HELOCs, and cash-out refinances, often have more favorable interest rates than credit cards and personal loans. Before you start the process, it's essential to understand how you can access your home equity, depending on your financial goals and other factors.
Start by exploring your home equity options here now to learn more.
How to use home equity while prices are still high
Here are four home equity options to strongly consider using now while prices are still high.
A home equity loan
A home equity loan is an installment loan that allows you to borrow 75% or 85% of your home's equity for virtually any purpose. Generally, these loans come with fixed interest rates and repayment terms ranging from five to 30 years. Like other home equity borrowing options, you must put up your home as security for the loan, meaning you could lose your home if you default.
Remember, your home equity is the difference between the balance you owe on your mortgage loan and your home's current market price. Let's say you purchase your home for $400,000 and pay $100,000 on your mortgage over time, your mortgage balance would be $300,000. At the same time, your home rises $100,000 to a $500,000 fair market value. In this case, your home equity would be $200,000 ($500,000-$300,000). If your lender allows homeowners to borrow up to 80% loan-to-value (LTV), you may qualify for a $160,000 home equity loan (200,000 x 80%).
Of course, you should only borrow the amount you need since you'll pay interest on your entire loan. With good credit, you may qualify for a home equity loan with rates as low as 6.64% to 13.99%. By comparison, the Federal Reserve lists the average credit card and 24-month personal loan rates at 20.92% and 11.48%, respectively.
Check out your home equity loan options here to learn more.
A HELOC
A home equity line of credit (HELOC) allows you to access your home equity as revolving credit, much like a credit card. One of the key benefits of HELOCs is that you don't have to withdraw the entire amount you're approved for. As revolving credit, you can borrow only as much as you need, when you need it. Remember, you're only charged interest on the amount you withdraw from your HELOC.
As with home equity loans, you'll need to account for any closing costs, ranging from 2% to 5% of the amount you borrow, although some lenders do not impose closing fees. Of course, you'll want to shop and compare interest rates among lenders to get the best rate.
Ben Miller, branch manager at American Mortgage Network, acknowledges the importance of getting a lower interest rate but advises borrowers to keep rates in perspective. "Base your decision about your HELOC term and your HELOC amount based on cash flow, not based on interest rates," says Miller. "Where is your budget? Let's talk about your comfort zone. Where do you need to be? Now we're talking about dollars because that's the family's budget, based off actual dollar amounts. It (interest rates) really does make up the dollar amount, but it's not daily life."
Check your HELOC options here to learn more.
A cash-out refinance
A cash-out refinance involves refinancing your existing mortgage while tapping into a portion of your home's equity. Ultimately, you'll end up with a single loan with a larger loan amount. While home equity loans and HELOCs are second mortgages, an additional loan alongside your first mortgage, a cash-out refinance is a single loan.
For instance, let's say you have a home worth $800,000 on the market and $400,000 remaining on your mortgage balance. Lenders typically allow you to borrow up to 80% loan-to-value, meaning you may qualify to borrow as much as $320,000 (80% of $400,000 home equity). With a cash-out refinance, you would take out a new loan, which you would use to pay off your current mortgage, resulting in cash at your disposal.
While the cash could come in handy, be aware you're taking on more debt. And if you're starting a new 30-year loan, you could pay more interest over the life of the loan.
Check your refinance options here to learn more.
A reverse mortgage
Many retirees and older Americans might consider a reverse mortgage to use their home's equity to help meet living expenses or other purposes. The most common type of reverse mortgage is called a Home Equity Conversion Mortgage (HECM) and is only available to homeowners who are 62 and older. With this mortgage, you must continue to use the home as your principal residence, but you no longer have to make monthly mortgage payments. Instead, you or your heirs will repay the loan when you no longer live there.
However, your balance will continue growing as interest and fees are tacked on to your loan balance each month. You're still responsible for paying property tax and homeowners insurance. A reverse mortgage may benefit seniors who are "house rich," with abundant home equity but short on cash flow for day-to-day expenses. Be aware, however, that your balance will rise, and your home equity will fall over time. Ultimately, you or your heirs must repay the loan, which most people do by selling the home.
The bottom line
With home prices significantly higher than before the pandemic, you may have enough home equity to access the cash you need for an emergency expense, debt consolidation or nearly any legal purpose. With home equity loans, HELOCs and cash-out refinances, you may even qualify for a tax deduction "if the proceeds were not used to buy, build, or substantially improve a qualified home," according to the IRS.
However, reverse mortgages are not eligible for the tax deduction because the interest is considered interest on home equity debt. Before you apply, do your due diligence to determine how a new loan payment would fit within your budget. Additionally, shop and compare lenders to identify which one offers the lowest costs.
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How to use home equity while prices are still high - CBS News
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