You may not feel it yet, but if you're an American homeowner, you're probably a good bit richer after the dizzying run-up in housing prices last year. But how do you tap into your newfound wealth? And should you?
U.S. homeowners gained an average $55,300 in home value (minus their mortgage) in 2021. In some especially hot cities, such as Denver and Miami, the increase was close to $80,000, while in high-price Los Angeles and San Francisco, it was more than $110,000.
That's a remarkable jump considering it's taken three to four years to see gains of $50,000 in prior rising markets, said Frank Nothaft, chief economist at real estate analytics firm CoreLogic.
For anyone wanting to sell, it's a windfall: just find a buyer and turn that appreciation into cold hard cash. But what if you're happy staying put? With all the current market volatility, inflation and other economic uncertainty, it's only natural to want to tap those gains now, perhaps by borrowing against your newly increased equity (the difference between your home's current value and what you owe on your mortgage).
Is it safe, though, to use your home as an ATM, especially as fears of a recession loom? It actually can be a smart play, if you use the money wisely and pick the right loan product.
The two main options for tapping equity are to refinance a mortgage or acquire a home equity line of credit. For the first, you use your home's higher value to secure a bigger mortgage at a set interest rate, pay off the original smaller loan with the proceeds, and pocket the difference. But most people who could benefit from such "cash-out refis" did so before interest rates started to head higher.
So let's look more closely at the home equity line of credit. If you're looking to do home renovations, tapping home equity can be a prudent way to do it. A line of credit usually makes the most sense because you don't have to know exactly how much you'll be spending. You're approved to borrow a certain amount at an interest rate that typically floats with the market, and then you can draw money as you need it. (With a cash-out refi, you receive a lump of cash all at once, whether you plan on using all of it or not.)
If you're in good financial shape--meaning you're doing all the things advisers say you should, such as putting money away for retirement--and you plan to use the money to, say, upgrade your home office situation or improve your backyard, go for it. You'll create more value in your home and make your life more enjoyable, too.
If it still feels scary to borrow against equity that magically appeared in the past year (might it disappear just as quickly?), take solace in the fact that, thanks to the housing bust 15 years ago, we have many more guardrails these days when it comes to borrowing against home equity. Banks limit how much you can take out, and they require more documentation to qualify than they used to.
Also, unlike in 2007, the continuing tight housing supply means that while home price appreciation may slow down, prices are unlikely to drop anytime soon. (Do be wary, though, if you're in a so-called Zoom town that has seen huge price run-ups thanks to an influx of remote workers; your housing market could be more vulnerable as more people return to the office, points out Freddie Mac economist Len Kiefer.)
There are some uses for home equity that can be riskier. For instance, a line of credit might come with an initial rate of about 4 percent, so using it to pay off high-interest credit-card debt sounds good in theory. If you're a disciplined spender and you're paying off longstanding debt or maybe a large one-time expense, you're getting a good deal with the lower interest rate.
But if you're likely to see those paid-off balances as a chance to run out and spend more, using your home to finance credit-card debt could get you into trouble, especially if the loan rate rises significantly.
Another caution: Home equity lines of credit usually require you to pay just the interest for the first few years. So borrowers can be hit with a double whammy if the rate resets higher and they have to start repaying their borrowings, too.
Dipping into your home equity to help with monthly expenses, especially amid rising gas and food prices, can also be dangerous. Home equity isn't really suited to ongoing daily costs.
Once you have access to that tempting pile of cash through a line of credit, it can be hard to stop going back to it, and you could wind up borrowing more than you intended. Also, keep in mind that the best rates and terms for home equity products are usually reserved for those in the best financial standing. If you're struggling, the banks' terms may not be that attractive.
While lines of credit typically come with much smaller closing costs than a cash-out refinancing, the biggest turnoff is their adjustable rates and the difficulty in managing bigger payments down the road. For that reason, some banks offer the option of taking out a fixed amount at a set interest rate within the line of credit, which can provide the best of both worlds.
Another option to avoid ballooning payments is to pay more than the minimum interest amount required in the early days of the loan, says Sophia Bera, a certified financial planner in Austin, Texas.
For the best deals, consider working with smaller banks and credit unions. They want the business and may be more comfortable than the bigger banks with keeping your loan on their balance sheets.
Finally, Bera says she's been advising clients who may be changing jobs or starting their own businesses to apply for a line of credit now before their incomes change to secure the best rates, especially if they don't want to tap into their savings. That has some merit. In a topsy-turvy world, a potential lifeline amid major changes isn't such a bad idea.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.