Why high interest rates make it difficult to tap into home equity

Home values ​​are almost at a record high. But tapping it could be difficult because of high interest rates, financial advisors said.

Total home equity for US mortgage holders rose to more than $17 trillion in the first quarter of 2024, just below the record of the third quarter of 2023, according to new data from CoreLogic.

Average equity per borrower increased by $28,000 to about $305,000 total compared to a year earlier, according to CoreLogic. Chief economist Selma Hepp said this is almost 70% more than the $182,000 before the Covid-19 pandemic.

About 60% of homeowners have a mortgage. Their equity is equal to the value of the house minus the outstanding debts. Total home equity for American homeowners with and without a mortgage is 34 trillion dollars.

The jump in home equity is largely due to a rise in home prices, Hepp said.

Many people also refinanced their mortgages earlier during the pandemic, when interest rates were “very, very low,” which may have allowed them to pay off their debts more quickly, she said.

“For the people who owned their homes at least four or five years ago, they’re feeling fat and happy on paper,” said Lee Baker, founder, owner and president of Apex Financial Services in Atlanta.

However, Baker, a certified financial planner and member of CNBC’s Advisor Council, and other financial advisors said access to that wealth is made more difficult by high financing costs.

“Some options that might have been attractive two years ago are not attractive now because interest rates have risen so much,” said CFP Kamila Elliott, co-founder of Collective Wealth Partners and also a member of CNBC’s Advisor Council.

That said, there may be some cases where it makes sense, advisers say. Here are a few options.

A home equity line of credit, or HELOC, is typically the most common way to tap into real estate wealth, Hepp said.

A HELOC allows homeowners to borrow against their home equity, usually for a specific term. Borrowers pay interest on the outstanding balance.

The average HELOC has an interest rate of 9.2%, according to Bankrate data as of June 6. Interest rates are variable, meaning they can change, unlike fixed-rate debt. (Homeowners may also consider one equity loanfor which fixed rates generally apply.)

For comparison: the rates for a 30-year fixed-rate mortgage are about 7%said Freddie Mac.

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Although HELOC rates are high compared to typical mortgage rates, they are much lower than credit card rates, Elliott said. Credit card holders with an account balance have a average interest rate of about 23%, according to Federal Reserve data.

Borrowers can generally do that tick up to 85% of their home value minus outstanding debt, according to Bank of America.

Homeowners can use a HELOC to pay off their outstanding high-interest credit card debt, Elliott said. However, they should have a “very focused plan” to pay off the HELOC as quickly as possible, ideally within a year or two, she added.

In other words, don’t just make the minimum monthly debt payment — which could be tempting because those minimum payments would likely be lower than those on a credit card, she said.

Likewise, homeowners who need to make repairs or improvements to their home can use a HELOC instead of using a credit card, Elliott explained. This could provide an added benefit: Those who itemize their taxes may be able to deduct the interest on their loans on their tax returns, she added.

a reverse mortgage is a way for older Americans to tap into their home equity.

Like a HELOC, a reverse mortgage is a loan against your home equity. However, borrowers don’t pay off the loan every month: the balance grows over time with accrued interest and fees.

A reverse mortgage is probably best for people who have a large portion of their equity in their home, advisors say.

“If you were late, you got the ball rolling when you retired [savings]“It’s another potential source of retirement income,” Baker said.

A home equity conversion mortgage (HECM) is the most common type of reverse mortgage, according to the Consumer Financial Protection Bureau. It is available to homeowners age 62 and older.

A reverse mortgage is available as a lump sum, a line of credit, or a monthly payment. It’s a non-recourse loan: If you take steps such as paying property taxes and maintenance fees, and using the home as your primary residence, you can stay in the home for as long as you want.

Borrowers can generally tap up to 60% of their home equity.

According to the CFPB, homeowners or their heirs will eventually have to pay back the loan, usually by selling the home.

Although reverse mortgages generally leave less of a legacy for heirs, that shouldn’t necessarily be considered a financial loss for them: if there is no reverse mortgage, those heirs may still have paid out of pocket to help the borrower’s retirement income subsidize, Elliott said. .

Historically, the biggest benefit of having home equity has been accumulating more money to put into a future home, Hepp said.

“That’s historically been the way people have moved up in the housing market,” she says.

But homeowners with low mortgage rates may feel trapped in their current home due to the relatively high interest rates that come with a new loan for a new home.

Relocating and downsizing remains an option, but “that math doesn’t really work in their favor,” Baker said.

“Not only has their house gone up in value, but so has everything else in the area,” he added. “If you try to find something new, there’s only so much you can do with it.”

A cash-out refinance is another option, but should be considered more of a last resort, Elliott said.

“I don’t know anyone at this point who is recommending a cash-out refi,” she said.

With a payout, you replace your existing mortgage with a new, larger mortgage. The borrower would pocket the difference as a lump sum.

To give a simple example, let’s say a borrower has a house worth $500,000 and an outstanding mortgage of $300,000. They can refinance a $400,000 mortgage and receive the $100,000 difference in cash.

Of course, they would likely refinance at a higher interest rate, meaning their monthly payments would likely be much higher than their existing mortgage, Elliott said.

“Really look at the numbers,” Baker said of homeowners’ options. ‘Because you are burdening the roof over your head. And that can be a precarious situation.’