Is tapping home equity a good idea?
A home equity loan or home equity line of credit, known as a HELOC, can be a tremendous help to a homeowner, providing funds for needed renovations and repairs or some other practical purpose. The loans and lines also can be a destructive temptation to treat a house like an ATM, drawing out money for frivolous purchases or everyday expenses while piling up debt against a major asset.
These mortgage products, which allow an owner to borrow against the value of his or her home, were wildly popular and easy to come by when house prices were rocketing upward 10 years ago. As the mortgage crisis hit in 2007 and the housing market later went into a tailspin, all that changed. Home equity loans and HELOCs fell out of favor in a big way. Many homeowners no longer had enough equity in their homes to consider applying for them. Meanwhile, banks tightened lending standards, making the loans more difficult to obtain even for those who appeared to qualify.
Now the landscape has shifted again. The housing market is recovering, home prices are rising in most places, and interest rates remain historically low. Home equity loans and HELOCs are back.
What’s changed on the home equity front
Home equity loans and home equity lines of credit are surging in popularity once more, but this time the rules are different. Michael Kinane, TD Bank’s head of consumer and mortgage lending, recently told the Washington Post that home equity lines “are much safer” now than a decade ago for both borrowers and lenders. Lending standards have tightened, and the Post notes: “Most banks now limit the combined loan-to-value ratio — the total of the primary mortgage balance plus the maximum draw amount on the new credit line compared with the home value — to 80 percent.” In short, a homeowner will not be allowed to borrow more than 80 percent of his or her home’s appraised value. Before signing off on a HELOC, most banks also demand full documentation of income, employment, credit and property values. Unlike the go-go days of the housing market, home equity loans are no longer given lightly.
When to avoid tapping home equity
Properly used, home equity loans or a home equity line of credit can be powerful tools, but there are times when it makes more sense to resist the urge to tap equity. Before making a final decision, be an informed consumer and understand the consequences to your financial planning. Follow this checklist to avoid home equity loan mistakes.
1 You live in an area with stagnating or depreciating home values.
While much of the nation is again experiencing appreciation, some real estate markets have been slow to bounce back from economic downturn. Remember, real estate is local, and not every market grows at the same pace. Even at the height of the real estate boom, some real estate markets experienced very little growth or a loss of value.
2 You intend to sell your home.
Even if you have equity in your home, be careful before taking out a home equity loan or HELOC if you intend to sell your home in the near future. Transactions costs including closing costs, real estate fees and other expenses can add to the price of the home and make your home appear less affordable.
3 You intend to buy another home or obtain financing in the near future.
A HELOC or equity loan will increase your debt-to-income ratio and could affect your ability to obtain new financing.
4 Your personal or financial situation is not stable.
If your income, job situation or other personal life events are subject to change for the worse, then think twice before taking on more debt.