American homeowners are house rich, sitting on a record amount of home equity.
Taking advantage of all that extra cash, however, becomes more difficult as interest rates rise.
Soaring housing demand over the past year and a half, driven in large part by the pandemic, caused home prices to spike. There simply wasn’t enough supply to meet the demand. Prices have now climbed close to 20% from a year ago.
As a result, homeowners gained a massive amount of tappable equity — the sum borrowers can generally take out of their homes while still leaving at least 20% as a cushion. By the end of the third quarter, borrowers had a record $9.4 trillion in tappable home equity collectively, or an average of $178,000 per borrower, according to Black Knight, a mortgage data and analytics firm.
That marks a 32% jump year-over-year.
As the available cash climbed, borrowers took equity out of their homes during the third quarter at the highest rate in 14 years. It was relatively inexpensive for them because mortgage rates were low at the time, with the average rate on the 30-year fixed under 3%, according to Mortgage News Daily.
Now rates have ticked above 3% and are expected to rise further as the Federal Reserve slows its purchases of mortgage-backed bonds. As rates rise, a cash-out refinance becomes less attractive because a lot of borrowers would have to refinance to a higher rate than they currently have.
As of now, 24% of all first lien mortgages have an interest rate below 3%, according to Black Knight.
Borrowers could take out a home equity line of credit, which is a second lien, but those generally have variable interest rates, meaning they can move higher or lower. Some lenders will offer shorter fixed terms, but all home equity lines have a draw period and a repayment period.
So borrowers can draw on that line of credit for, say, 10 years, but then after that period they have to start paying the money back. They do have to pay interest on the money they take out during the draw period.
Moving from the draw period to the repayment period can be a shock to borrowers’ wallet as well, since they have to pay both interest and principal.
“You have to take the whole picture into consideration — current debt amount and associated interest rates, how much you’re looking to borrow, available HELOC vs. cash-out rate offerings, timeline for paying off the additional debt, and so on,” said Andy Walden, vice president of market research at Black Knight. “To make the best decision, homeowners need to run the numbers both ways and see what makes the most sense for their particular case.”
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