Home equity borrowing on the rise: What homeowners should know

If you’ve been looking for info on home equity loans, you’re not alone. Online searches for “HELOC” (home equity line of credit) rose 305 percent this year, reaching an all-time high in July 2023, according to a Google traffic analysis by real estate platform RubyHome.

People aren’t just looking, though — a lot of them are moving forward with an application. Research from ATTOM, a curator of real estate and property data, shows that lenders originated more than 284,000 HELOCs in the second quarter of the year – a sizable jump from the 251,975 HELOCs borrowers opened in the first three months of 2023. And a report from the Mortgage Bankers Association projected that debt from home equity loans, HELOC’s fixed-rate cousins, would increase over 11 percent in 2023.

Clearly, home equity lending is having a moment. Why? While rates for HELOCs and home equity loans — like interest rates in general — have increased in the last year, borrowing against your ownership stake is still looking better than alternatives such as refinancing a mortgage or taking out other types of loans. That’s especially true if your need for cash relates to home remodeling, renovation or repair (the leading reasons people tap their home equity).

Let’s look deeper into why home equity loans and HELOCs are on the rise, and what you should know if you are tempted to join the trend.

Homeownership/home equity statistics

What is home equity?

Why are homeowners tapping into their equity?

With borrowing costs going up, why are homeowners taking advantage of HELOCs and home equity loans? Largely because they can. The pandemic-fueled real estate boom has led to lofty ownership gains in the past two years. About half of homeowners who have mortgages are in “equity-rich” territory, meaning their outstanding loan balance is only half or less than what their home’s worth, ATTOM reports.

As to their motives: Many people are tapping into their home equity to spruce up their homes, and better equip them to meet their family’s needs. Borrowing money to upgrade their current home makes a lot more sense than trying to buy into a new one nowadays. According to research from Redfin, more than 90 percent of homeowners have a mortgage rate below 6 percent; four out of five are paying less than 5 percent. This means that the math of moving simply doesn’t add up: They would need to deal with near-record-high housing prices paired with some of the highest mortgage rates in the past two decades.

That combination is scaring people into staying put and sprucing up. Data from the Mortgage Bankers Association shows that about 66 percent of those who applied for home equity lending products last year cited home renovations and remodeling efforts as a reason. That demand seems poised to continue.

“Homebuying activity is slowing down dramatically,” says Rick Sharga, executive vice president of Market Intelligence with ATTOM. “With more homeowners deciding to stay in place, there will probably be more home improvement projects being done, and HELOCs are a relatively affordable way to pay for those projects.”

Taking out a home equity loan makes more sense than a cash-out refinance (in which your new mortgage includes a lump sum to play with) these days. “Many borrowers have now locked into historically-low rates on their first mortgage, which makes a cash-out refinance a costly option for tapping the equity in the home,” says Adam Boyd, senior vice president, head of home equity lending, credit card and unsecured lending at Citizens Bank — “even if mortgage rates eventually come back down somewhat.”

Of course, there are plenty of other reasons that tapping home equity may make sense. If you’re paying off a large chunk of credit card debt, a home equity loan might be a lower-cost way to work toward eliminating that balance. Additionally, if you’ve incurred any major expenses – medical bills, for example – a home equity loan or HELOC may be able to help save you money or simply consolidate all your debts into one convenient monthly payment. You also might just want to have access to cash to make it through a worst-case scenario. A HELOC can provide a safety cushion when you need it.

Rise of home equity over the years

The increase in home values has boosted the worth of homeowners’ equity stakes.

What does the home equity loan boom mean for the housing market?

It could mean a lot more remodeled homes, for starters, and fewer homes hitting the market, as people hunker down and upgrade instead of moving. “More homeowners have postponed the idea of buying another place indefinitely — especially if they have a mortgage rate below 4 percent,” says Greg McBride, chief financial analyst at Bankrate. “Upgrading or expanding where you are has become the most viable option for many homeowners.”

However, the borrowing costs for making those upgrades aren’t nearly as cheap as they used to be. Home equity interest rates have risen dramatically, along with those of just about every other debt product, in the last year. For example, rates on 10-year HELOCs averaged 5.49 percent in July of 2022. In October of 2023, Bankrate data showed rates were averaging 8.75 percent on home equity loans and 9 percent for HELOCs.

There is one bright spot, though: If you use a HELOC or home equity loan for housing-related repairs or remodels, the interest can be tax-deductible. That can reduce the real cost of your financing.

Your house is on the line

Another potential concern of the equity borrowing boom: More homes could wind up in foreclosure or in financial straits, due to homeowners borrowing blithely without fully realizing the consequences. McBride points out that paying off credit cards or other debts with a home equity loan puts the roof over your head on the line.

“When you take unsecured credit card or personal loan debt and secure it with your home, the consequences of default are a whole different ball game,” McBride says. To put it bluntly, you could lose your home — as collateral for the loan, it can be seized to pay off your debt.

Equity values could fall

Admittedly, that’s a worst-case scenario. But be aware that if home values fall, your house could be worth less than all the outstanding mortgage(s) on it, a situation known as “being underwater.” This means you owe more than your home’s worth — you have “negative equity,” in real estate-lending lingo.

In some parts of the country, the share of seriously underwater homes – defined as having a balance of loans that are worth at least 25 percent more than the actual property value – is troubling. For example, according to a recent report from ATTOM, more than 10 percent of mortgaged homes in Louisiana fell into the seriously underwater category in the second quarter of 2023. However, the potential for a wave of foreclosures is very low: Less than 3 percent of all properties with a mortgage fall into the “seriously underwater” category.

The point is simple: Be mindful of the trajectory of housing prices in your area, and don’t take on more debt if you’re concerned that your property value has the potential to drop. No one is predicting a Great Recession-like crash in the housing market. But nothing rises forever, and it’s dangerous to take on excess debt on the assumption that it does.

How to get the best home equity lending rate

Whether you’re hoping to add on a new kitchen or pay off that oversized credit card balance, a HELOC or home equity loan still presents a potentially less-expensive means to those ends. While there are differences in how each product works, the process of shopping around for one remains the same. Here are some tips:

1. Calculate your equity.

You know your home’s value has gone up, but you’re not sure where exactly you stand. Estimate your home’s equity by taking the difference between the value of your home and what you still owe on your mortgage. The best determination of value would come from a licensed appraiser, but for a rough idea, look at an online home price estimator or home equity calculator. Once you have a number, find your mortgage balance on your most recent statement, and do the math.

2. Get your credit in excellent shape before you apply.

Home equity financing requires a pretty strong financial profile, especially for lines of credit: The median credit score of successful HELOC applicants is around 775, according to the Urban Institute, and slightly lower for home equity loans. While many home equity lenders do approve applicants with lower credit scores, the rule that applies to every loan still rings true: Borrowers with higher credit scores always secure the lowest rates.

If you aren’t sure of the best way to boost your credit score, start by looking at your credit cards. A recent Bankrate survey found that 47 percent of credit card holders carry balances from month to month. Lenders will look at your credit utilization ratio and your minimum payment obligations when evaluating your application. The lower you can get those balances, the better off you’ll be – both in terms of likelihood to be approved and your overall financial well-being due to lowering your interest charges.

“It would not be uncommon for a 20-point move in FICO score to impact pricing by 0.50 percent to 1.50 percent, especially for borrowers with sub-700 FICO scores,” says Adam Boyd of Citizens Bank. “I would encourage borrowers to shop around to find the best offer.”

3. Start your search where you’re already banking.

While there are several types of home equity lenders, begin with the place you already know: your bank or credit union. A lot of institutions offer rate discounts — 0.25 percent or 0.5 percent savings — for customers who set up auto-pay from checking or savings accounts. But check out an offer or two from an online-only lender, as well — if eligible, you might be able to get your funds sooner, or for a lower cost.

4. Look for conversion options.

Some lenders allow borrowers to convert a revolving line of credit to a fixed-rate loan. For example, you might opt to switch over $25,000 of a $75,000 HELOC to a fixed-rate loan to avoid the shock to your budget down the road. While rates seem likely to taper off as the Federal Reserve wraps up its fight to tame inflation, additional rate hikes are always possible – and that’s bad news for variable-rate products like HELOCs.

5. Read the fine print.

While home equity loans and HELOCs tend to have significantly lower fees and closing costs than first mortgages, McBride still recommends comparison shopping and paying close attention to the loan proposal’s fine print. For example, some lenders will offer to cover the closing costs on a HELOC with a minimum time commitment.

“A lender might cover the costs as long as you maintain the line of credit for three years,” McBride says. “You don’t want to close it in two and a half years and then get hit with all those expenses.”

FAQs

• How does a home equity loan work?

  A home equity loan is a second mortgage that allows you to borrow against the equity stake you have built up in your property. It’s another loan with a separate set of payments that you’ll make in addition to the payments you make on your first mortgage. With a home equity loan, you will receive a lump cash sum that you will begin paying back immediately with interest.
  

• How do you get a home equity loan?

  To get a home equity loan, you’ll need to meet your lender’s requirements. Those look different from lender to lender, but generally, you’ll need to have a sizable chunk of equity, a credit score in the mid-600s (higher is better), a debt-to-income ratio below 43 percent and proof of a steady stream of income. Keep in mind that you won’t be able to borrow against your entire chunk of equity, either; most lenders want borrowers to maintain a minimum of 15 percent equity in the property.
  

• How can you increase your home equity?

  There are a few ways to increase your home equity. You can make bigger payments against the principal balance, paying down your mortgage faster (and increasing your ownership stake). Or you can increase your home’s value by making it a more desirable place to live with a new kitchen, additional bathroom, finished basement or some other project that will make it worth more to a prospective buyer. Additionally, although it’s beyond your control, your equity can naturally increase due to rising property values in your town or neighborhood.