You live in a property equity piggy bank. Should you tap into it?

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If you bought your home before you heard the term “COVID-19”, you probably have a property that is worth much more than what you paid for.

The price of a home has risen dramatically in recent years – about 20% last year – as demographics, remote working and stiff competition have driven up demand for homes across the country. That means owners are sitting on a lot more equity than you might think.

You can use the equity in your home in a variety of ways, borrowing to get money that you can use for all sorts of things. The question is, is it wise to treat your home like a piggy bank?

“There’s going to be temptation”, says Marc Hinshaw, co-founder and president of Candor Technology, a mortgage technology company. “They suddenly think they’ve hit the lottery.”

Experts say there are ways to borrow prudently against your home equity using home equity loans and lines of credit (HELOCs), but you should beware of the risks, namely that, as a mortgage, failure to repay could cost you your money. residence.

“It can be valuable money for people, especially for those who have owned their homes for a long time,” says Linda Sherry, director of national priorities for Consumer Action, a national advocacy group. But she warns borrowers to be careful when withdrawing cash for non-essential goods. “If it’s not a need and it’s just some kind of want or desire, you should really ask yourself: is this wise?”

Here are some things the experts say you should consider before mining all that equity.

Houses are very valuable

Nearly half of mortgaged residential properties in the United States were considered “action-rich” in the first months of 2022, according to real estate data firm ATTOM. This means that the value of the property was more than double what was owed on any loans secured by it, such as a mortgage.

Property values ​​are on the rise due to the incredibly hot real estate market of the past two years. Relentless competition for a limited number of available homes means that any home that comes on the market is bound to be priced higher than expected. There are signs that could be slowing down a bit, as mortgage rates have risen dramatically since the start of the year, but house prices have yet to come down or even slow down significantly in much of the country.

The ephemeral nature of the housing market is one reason to be wary of this equity windfall, Sherry says.

“Houses go up and down in value,” she says. “I think you have to look at the situation as if the amount you could sell your house for might go down in the future and you don’t want to borrow too much because at closing you would have to repay an unusually large sum. You could find yourself underwater in a very bad scenario, where you owe more at closing than you were actually able to sell the house for.

While homeowners may feel reassured by the idea that they’re “stock-rich,” it’s not as if their homes are jam-packed with $100 bills. Hinshaw compares it to a company with a lot of assets but not necessarily bringing that money into its profit and loss accounts. “It’s a rich record,” he said. “It’s not P&L rich.”

What can you do with the equity in your home?

Taking out a home equity loan or line of credit is one way to get the cash you need for a big expense, but experts say some uses make more sense than others.

Home improvement

The most commonly cited way a home equity loan is used is to spend that money on home repairs or improvements, whether they are needed, such as replacing a leaky roof, or major value-added projects, such as kitchen renovations.

The improvements needed are logical uses for home equity loans, Sherry says. Repairs or upgrades that could increase the value of the home also make sense if you plan to sell soon. But don’t assume everything will be worth the investment when you go to sell.

“It’s well known that some home improvements don’t yield as much equity as others,” says Sherry. “If you were to spend $40,000 on a new kitchen, would that increase the value of your home by $60,000? Maybe, but maybe not.

Debt Consolidation

Another popular use of home equity loans and HELOCs is to consolidate higher interest rate debt, such as credit card debt and student loans. It may make sense, but be careful, says Vikram GuptaHead of Home Equity at PNC Bank.

“If you’re a homeowner and have existing debt, using your home to help pay off high-cost existing debt is a fantastic idea if you do it sensibly and prudently,” and if you don’t overdo it. , he said.

Not all experts agree that debt consolidation is worth putting your home at risk. There are other ways to tackle higher cost loans without putting your home at risk, Sherry says. “Take your highest rate credit card and attack it so that you pay more than you need, as much as you can, and pay it that way instead of borrowing against your house,” says -she.

For other purposes

Some experts say you should consider having a HELOC on hand before any planned home improvements or other major expenses, so you can take advantage of it if you need it. “If you own, you use the smartest capital possible. I don’t like people referring to this as consumers using their home as a piggy bank,” says jim albertelliCEO of Voxtur Analytics, a real estate technology company.

Be careful, because it can be “a little tempting for a lot of people,” Sherry says. “Remember, having that line of credit doesn’t necessarily mean you have to use it every five seconds. It should be something that you are very disciplined for.

One important thing to keep in mind is that you must be able to repay this debt in the future. “If they’re not confident in their ability to generate cash flow in the future, they should hold off,” Hinshaw says. “It doesn’t make sense to be over-indebted.”

What are the risks of home equity loans?

Home equity loans and HELOCs have many advantages over other types of debt, such as personal loans and credit cards. They have lower interest rates and generally more favorable terms. But these advantages exist because if you don’t pay, the bank can take your house.

“That risk still remains where you use your home, but if used wisely and wisely, it’s a more cost-effective way than borrowing without collateral,” Gupta says.

Know your loan

It’s also important to understand how the loan you’re using works and what the pros and cons are. Sherry cautions against HELOCs and interest-only loans, in which your initial payments only cover the interest and do not reduce the outstanding principal. “You’re going to end up in even more debt and what they’re asking you to pay won’t be enough to reduce the principal you’ve borrowed,” she says.

Lending standards have changed

Home equity loans played a big role in the financial crisis of the 2000s, as lax lending standards and high housing costs have led people to treat their homes like an ATM. That is no longer the case, experts say, as regulations imposed in the wake of the crisis mean banks and other lenders are working diligently to ensure borrowers can repay.

Pro tip

Going through the paperwork to qualify for a loan can be daunting, but it’s worth knowing you can repay the money.

“There were no regulations. Lenders lent very freely without verifying the repayment capacity of the borrower. Clients overborrowed, used their house as a piggy bank,” says Gupta.

One key is to make sure your lender takes the loan — by going through your credit history and asking for documents, Sherry says. “You might find it annoying to be asked all these personal questions about your finances and so on, but ultimately it’s to protect you,” she says. “If you received a loan with few questions asked, that’s a red flag right there.”

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