Why is Home Equity Borrowing on the Rise?
Trends in consumer finance are often complex, but the growing rate of home equity borrowing is actually quite easy to explain. Americans have more equity in real estate than ever before, and all that equity can be used to borrow money at competitive interest rates.
Understand the History
To understand the trend in home equity borrowing, we can look back to the Great Recession. Between the start of 2000 and Q1 2006, US household home equity more than doubled from $6.2 trillion to $13.4 trillion. The value of HELOC originations rose about 7-fold, from around $50 billion in 2000 to $364 billion (divided among some 3.3 million borrowers) in 2005, according to CoreLogic. By 2009, after the full impact of the US housing crash had been felt, household home equity had dropped back to around 2000 levels and so too had HELOC originations.
The story since 2011 has been one of strong recovery. Household home equity had more than doubled to an all-time high of $15.5 trillion by the end of 2018. The number of approved HELOC borrowers has increased in lockstep, from around 600,000 people in 2011 to 1.2 million in 2017, according to credit bureau TransUnion.
Home equity is the difference between a home’s fair market value and the outstanding balance of all liens (such as mortgage balance) on the property. House prices and interest rates have both been on the rise since 2011, causing American homeowners to stay in their homes for longer and build up equity. TransUnion estimates that around 70 million Americans are eligible for home equity products.
Why aren’t HELOCs growing quite as quickly as during the boom years of the early 2000s?
In the wake of the recession, lenders stopped educating consumers about home equity products, according to Joe Mellman, head of TransUnion’s mortgage division. Lenders have become more conservative since the recession. Between 2000 and 2006, the average combined loan to value (CLTV) of HELOC originations was around 75%-77%, according to CoreLogic. Since 2011, the average has been around 60%-62%, while the average credit score of approved HELOC borrowers has risen more than 30 points to around 770-775.
What is a Home Equity Line of Credit?
A Home Equity Line of Credit, or HELOC, is a line of credit secured by the borrower’s home. The borrower gets a revolving credit line up to a pre-agreed limit. Most borrowers use HELOCs for debt consolidation or large expenses like home improvements.
Home equity loans and personal loans use fixed rates, while HELOCs use adjustable rates. The minimum credit score for a HELOC is 620, although some lenders have stricter requirements.
HELOCs have been the most popular home equity product since at least 2009, and their popularity keeps growing relative to home equity loans and cash-out refinance. More than 1.2 million HELOCS were originated in the United States in 2017, according to TransUnion. In comparison, there were around 800,000 HEL and 600,000 cash-out refinance originations.
TransUnion has predicted that 10 million homeowners will take out a HELOC between 2018 and 2022. This would more than double the 4.8 million HELOCs originated between 2002 and 2016.
Types of HELOC Borrowers
Consolidate balances from other credit products, usually to a lower interest rate
Finance a large credit need (e.g., home renovation project)
Refinance a HELOC, often to change terms or to get a better rate
Concurrent with a mortgage origination, often used as part of a down payment
Standby, undrawn line of credit for a ‘rainy day’
HELOCs vs HELs: Pros and Cons
Because of the similarities between HELOCs and HELs, many lenders offer both products. HELOCs and HELs both let homeowners borrow against their equity. They tend to have the same requirements such as maximum CLTV of between 80% and 90% and the same minimum credit scores.
The major differences are that a HELOC is a line of credit with an adjustable rate, while a HEL is a loan with a fixed rate. With a HELOC, the homeowner gets to withdraw funds at any time and only pays back what they take out. Because a HELOC is a “revolving” line of credit, the homeowner may re-draw funds after they have paid them back. A HEL is similar to a personal loan in that the borrower receives the funds in one lump sum and must repay the funds over a certain duration of time.
Because HELOCs come with adjustable rates, they offer the advantage of a lower interest rate at the beginning. This can be a good thing for the homeowner if they plan to pay off their line of credit quickly or if interest rates stay low across the duration of their line of credit. If rates increase, a HELOC can quickly become more expensive to repay.
HELOCs vs Cash-Out Refinance: Pros and Cons
A cash-out refinance is a type of mortgage refinance where the home owner borrows more than what their house is worth and keeps the difference in cash. Like a HELOC, a cash-out refinance may be used to pay off credit card debt or fund a large expense like home improvement or a child’s college tuition.
Cash-out refinance is a less popular option because fewer people are in a position to benefit from it. The key word here is “refinance”: a cash-out refinance is like any other refinance in that it involves taking out a new mortgage on your home at a different rate. Because closing costs are also involved, the new rate must be at least 0.75% lower than the old rate in the first few years of a mortgage. This threshold rises to 1%-2% the closer the homeowner is to paying off their mortgage. According to the Black Knight Mortgage Monitor monthly report for March 2019, today more than 4.9 million homeowners could reduce their interest rate by at least 0.75% by refinancing.
Comparing Home Equity Products
HELOCs are the most popular home equity borrowing product and are expected to enjoy rapid growth in the next few years. Of course, the best home equity product for you depends on your needs and on whether you meet the minimum qualification requirements.
Before taking out a HELOC (or a home equity loan or cash-out refinance), always compare the top lenders to find the best deals. HELOCs can vary in terms of interest rate, terms, minimum credit score, and maximum CLTV. The best way to find the best HELOC is to do comparison shopping between lenders.