People aren’t exactly lining up for mortgages these days. Thanks to higher mortgage rates—which now sit above 7%—mortgage purchase applications in the first week of August were down 27% compared with a year earlier. The number of refinances has dipped even more.
Home-equity loans and home equity lines of credit, though? Those are an entirely different story. “There has been a massive increase” in borrowers taking out these types of loans in the past few years, says Jeff Levinsohn, CEO of equity tracking platform House Numbers.
In the second quarter of 2023, the number of new home-equity loans and Helocs jumped by 53% and 21% respectively compared with the same period in 2021, according to credit bureau TransUnion. (That is when mortgage rates were below 3%.)
“We’ve seen a significant increase in our home-equity loan and Heloc portfolio in the last two years,” says Susan Waite, who oversees lending at Point Breeze Credit Union in Hunt Valley, Md. “With the increase in first mortgage rates and high property values, homeowners are choosing to stay in their current home and tap in to their equity.”
Why are higher rates driving homeowners to home equity products? And might a home-equity loan or Heloc work for your financial needs? Here’s what you need to know.
How home-equity loans and Helocs work
Home-equity loans and Helocs—home equity lines of credit—are tools for borrowing from your home equity, or the portion of your property you actually own.
With a home-equity loan, you borrow a lump sum from your equity—typically up to 80% to 90% of your home’s value, minus your mortgage balance. You can then use the cash you receive however you wish, paying it back monthly—plus interest—over the course of 10 to 30 years. These are sometimes called second mortgages, and paying one back will look and feel similar to repaying your original loan.
Helocs work a little differently. Though you’re still borrowing from your equity and can use the money as you please, you don’t get the funds you borrow in one lump sum. Instead, a Heloc functions more like a credit cars, in that you get access to a line of credit you can pull from as needed.
Repayment is different too. With a Heloc, you’ll have a draw period—typically 10 years—during which you can access funds. Throughout this time, you’ll usually only need to make interest payments on the money you pull out. After that, you enter the repayment period. For some Helocs, this means making monthly payments for the next 20 years. For others, you may need to make a balloon payment, repaying the full amount you borrowed at once.
Why home-equity lending is popular right now
Demand for home equity products last peaked in the early 2000s, but the loans largely fell out of favor following the 2007-09 recession. In the past two years, though, there has been a resurgence—one that has gone hand in hand with increased demand for renovations.
According to the Center for Joint Housing Studies, Americans spent a whopping $473 billion on home renovations last year—up 16% from 2021 and 30% from 2020. Many used home equity products to cover those costs.
Though homeowners can technically use the funds they get from home-equity loans and Helocs for any purpose, last year, about two-thirds of all home equity borrowers used their loans for renovations or remodeling, according to the Mortgage Bankers Association. Another quarter used the money to consolidate debt.
Heloc & home-equity loan originations
|New Helocss||One-year change Helocs*||New home-equity loans||One-year change home-equity loans*|
*All 2023 figures are through the second quarter.
That surge in renovations has a lot to do with mortgage rates, which have jumped from a low of 2.65% at the start of 2021 to 6.96% today. As mortgage rates rose, homeowners became less interested in selling (which would mean trading in a low interest rate for a much higher one) and more apt to stay put and update their existing homes instead. According to Zillow, 80% of homeowners have rates of 5% or below on their current mortgage.
“With so many homeowners unable or unwilling to purchase new homes, they are turning to equity products as a cost-effective way of making their homes more livable with a renovation,” says Alex Madonna, an executive at mortgage lender loanDepot. “A renovation can also add value to your home, and in some cases, there may even be a tax advantage for borrowing against your equity for home renovation.”
Home equity products are a popular choice when paying for renovations because, as Madonna notes, you may be able to deduct the interest paid on a home-equity loan or Heloc in a similar way you can with a first mortgage if you itemize your taxes and you use the funds to “buy, build, or substantially improve your home.”
Home equity products also cost less than many other types of debt. According to the Federal Reserve Bank of St. Louis, the average credit card rate is now nearly 21%, while personal loans sit around 11.5%. At the same time, the average rate on home-equity loans is under 9%.
“Home equity products are almost always the cheapest debt, so the interest rates are lower than credit cards and other unsecured debt,” Levinsohn says. “It is a smart move to save money and lower your monthly payment—assuming, of course, you don’t run up debt again.”
Who can use home equity products?
To use a home-equity loan or Heloc, you need to start with a good amount of equity. Lenders generally require that you maintain at least 20% equity in the home after taking out a home-equity loan or Heloc. This means that your mortgage balance and your home-equity loan balance—when combined—can’t equal more than 80% of your home’s total value.
For example, if you had no other mortgage, you could borrow up to $320,000 on a home worth $400,000. If you have a $100,000 balance on your first mortgage, you could borrow up to $220,000 with a Heloc or home-equity loan.
Aside from having enough equity in your home, you will need to meet other financial requirements. It varies by lender, but you’ll usually need a credit score in the mid- to high-600s and a debt-to-income ratio of 43% or less, meaning your total monthly debt payments—including your new Heloc or home-equity loan payments—must equal 43% of your monthly income or less.
“Generally, a home-equity loan or Heloc is great for folks who are working full time, have predictable income, can afford the additional monthly payment and have a credit score above 640,” Levinsohn says. “If you’re paying off higher-interest debt with home equity, that helps you qualify. You’ll erase that monthly debt payment and often free up extra cash each month.”
Who should use a home equity product?
If you have a lot of equity in your home, home equity products can be a smart option if you need a large amount of cash, as other financial products such as credit card or personal loans tend to have lower loan limits and come with higher rates.
“While personal loans of up to about $50,000 are fairly common, it’s harder to obtain them for larger amounts—and then, they often come with higher interest rates,” says Kyle Enright, president of mortgage at digital finance company Achieve. “With a home-equity loan or Heloc—depending on the amount of equity you have in the home—much higher amounts are available.”
Home-equity loan or Heloc?
Both loan types let you turn the value you’ve built in your home into cash, but the right choice depends on a few factors.
First, do you know exactly how much you need to borrow? If so, a home-equity loan could be smart. If you don’t have a solid estimate—or you need access to money over an extended period (for college tuition, for instance)—a Heloc may be the better option, as it will allow you to withdraw money as needed, up to your credit limit.
You can even pay back what you’ve borrowed and withdraw more later on, as long as you’re still within your draw period. You also only pay interest on what you borrow, allowing you to simply leave the credit line untouched unless you really need it.
The size of payments you’re able to make matter, too. If you need lower payments for the near term—usually the next 10 years—a Heloc may be a better fit, as you’ll typically be required to make interest-only payments for that first phase of the loan. Just remember that once you enter the repayment phase you’ll need to pay both interest and principal and your payments will increase considerably, so be sure you have the funds ready to support that.
Whichever home equity product you choose, make sure you check the fine print to see if your Heloc requires a balloon payment or comes with variable interest rates, as some do, which means your payments could increase over time. As long as you’re prepared for this, though, and you fully understand the terms you’re agreeing to, “A Heloc or home-equity loan can be an excellent tool for financial wellness,” Madonna says.
More on home loans
- What Is a Home Equity Line of Credit?
- How to Choose a Home Equity Loan
- What Is a Cash-Out Refinance, and How Do You Get the Best Rates?
- How to Pay for a Home Renovation