Home equity lines: Remember them?
Gary Dekmezian | Improvement Center Columnist | January 5, 2015
During the economically troubled years of the recession, many lenders were unwilling to dole out home equity lines of credit (HELOCs) due to their risky nature. Some homeowners, seeing the value of their homes plummet and finding themselves underwater on their mortgages, had a tendency to default on payments.
But since 2013, housing market indicators have shown signs of economic revitalization. In March 2013 the S&P/Case-Schiller Index reported that housing prices rose 8.1 percent from January 2012, the biggest jump since June 2006, before the economic crisis began. Housing prices continued to rise in 2014, albeit at a slower, somewhat more erratic pace. The S&P/Case-Schiller National Index for September 2014, for example, posted a -0.1 percent change from August 2014. The 10-City Composite year-over-year posted a 5.5 percent gain in August 2014, but only a 4.8 percent gain in September 2014. Nevertheless, the consensus is that the housing market is stabilizing in response to higher employment rates and other favorable economic indicators.
What does this mean for the return of home equity lines of credit? HELOCs have been making a comeback. Here's why:
- Home equity is increasing due to the rising home prices.
- Mortgage rates are still low.
- Consumer confidence is stronger.
When the housing industry was at its peak in 2006, some homeowners were able to secure loans for 100 percent or more of their home's value, but with the prevalence of underwater mortgages home equity loans for any amount became scarce. A graphic on Marketplace.org shows just how deep America was still entrenched in the home equity crisis even in early 2013, with states such as Florida and Nevada reporting between 42-56 percent of mortgages underwater and 23 percent of all Americans stuck with negative equity.
Typically, lenders want to see a minimum of 20 percent equity in your home before they'll consider you for a mortgage loan or line of credit. The HELOC amount for which you may apply is based on your home's current overall value, as determined by an appraiser. You are responsible for the cost of hiring an appraiser as part of the application process.
Besides equity, what else are nervous lenders looking for from homeowners seeking HELOCs?
- An 80 percent loan-to-value ratio
- Proven track record of credit worthiness
- Excellent credit scores
- If you live in a state hard hit by the housing crisis, when and at what price you purchased your home in comparison to its current appraised value
If a major bank determines you are ineligible, a smaller lender or credit union might be worth approaching.
Once approved, the bank doesn't disburse the full amount as is the case with a home equity loan. Instead, like any other line of credit, you withdraw funds using a credit/debit card or checks on an as-needed basis. Interest is paid on the amount you take out (as opposed to the entire amount you have access to) and up to $100,000 of the loan is tax deductible.
Interest rates for HELOCs
Interest rates on HELOCs tend to be variable, meaning they are connected to another rate (LIBOR or prime rate) plus a premium or margin set by the lender. While mortgage rates are low now, economists predict that mortgage rates could start rising in 2015.
As rates rise, so will the amount you have to pay back each month, as interest rates for a HELOC are variable. The fine print ought to establish a maximum interest rate on your HELOC, but sometimes these figures may be much more than you would expect.
How you can use HELOCs
In the past people used HELOCs to pay for vacations and cars. Nowadays, people who qualify for a HELOC generally use the funds to pay off other loans:
- Credit card debts
- Student loans
- Auto loans
With credit card interest rates in excess of 12-25 percent and student loan interest rates 5 percent or more, the lower HELOC rate is attractive. The money is readily accessible, and the annual fees are generally less than $100. HELOC funds also come in handy for financing unexpected expenses, investment opportunities and home improvements.
Assuming current market trends continue, home values will continue to rise, but don't hinge your financial security on this assumption. After where the excesses of the last decade left some homeowners, the best approach to HELOCs is to live within (or below) your means and use the money wisely, rather than buy things your monthly income wouldn't otherwise afford.