Homeowners Tap Their Equity To Finance That Big Remodel

After slowing to a trickle, home equity lines of credit are back in vogue again.

The collateral for a HELOC loan is the borrower's equity in his house. These loans pretty much dried up after the housing and economic slumps caused home values to slide, leading to a surge in the number of underwater homeowners — those owing at least 25% more than the property's estimated value.

But a healthy increase in home values over the past couple of years, low interest rates and growing confidence in the housing market recovery have caused HELOC originations to soar through the year's first half.

The trend signals good news for remodeling spending. It was dampened by harsh winter weather in the first quarter that prompted homeowners to postpone projects, and it has yet to recover. But the new trend bodes well for home improvement product retailers.

In the 12 months ending in June, the number of HELOCs originated nationwide rose 20.6% to 797,865, the highest level since the 12 months ending June 2009, according to a recent report from foreclosure watcher RealtyTrac.

HELOC originations accounted for 15.4% of all loan originations in the U.S. during the first eight months of 2014 — the highest percentage since 2008, when the level was at 19.60%, and a big jump from the 9.53% level in 2013.

The main reason for the surge

"Thanks to the rise in home values over the last two and a half years, many homeowners have regained or built up equity in their homes that allows them to qualify for a HELOC," Daren Blomquist, vice president at RealtyTrac, told IBD.

To qualify, according to the Bank of America website, "the amount you owe on your home must be less than the value of your home.

Owners Rise Above Water

Meeting that threshold has become easier for many borrowers. Home values have risen 38.3% from March 2012 to September 2014, says Blomquist.

"Not only do people have more equity, they have the confidence in the housing market to go out on a limb more and leverage their equity," he said. "That says many people have confidence that the housing recovery is for real and not a temporary blip. (The recovery) has been going on two and a half years or more in many markets, which has created a foundation for more HELOCs.

The rebound in HELOC originations "speaks to the strength" of the housing market recovery, says Ken Fears, director of regional economics and housing finance at the National Association of Realtors.

"It's a reflection of lenders' confidence in consumers," Fears said.

Lenders "pulled back sharply" in providing HELOCs after the housing and economic slumps in 2008, he adds. But things have changed.

"The default rate has been coming down over the last two years, and we've seen strong price appreciation, which puts lenders in a more comfortable position, and it provides the equity necessary to draw on," Fears said.

But lending standards for HELOCs are still "tight," says Stephen Melman, economic services director for the National Association of Home Builders (NAHB).

Still, most lenders will let you borrow up to 85% of the value of your home minus the amount you owe, says Bank of America.

A HELOC might be used to consolidate debt, buy a big-ticket item like a car or even pay off a mortgage. But the primary purpose is to fund home improvement projects.

"The most financially wise use of a HELOC is to reinvest it back into the asset," said Blomquist. Piper Jaffray analyst Peter Keith agrees, saying that a popular use of HELOC funds is to pay for large-ticket home remodeling projects costing multiple thousands of dollars.

The HELOC growth trend bodes well for home improvement retailers such as Home Depot (HD) and Lowe's (LOW). Keith calls them the "biggest beneficiaries" of remodeling activity supported by HELOCs, as both have "large exposure" to the home remodel market and to a wide range of projects.

A Boon For Builders?

Blomquist says that the increase in HELOC originations is also a "good sign" for homebuilders.

"The upward trend in HELOCs does indicate more people have equity (in their homes) and are confident enough in the market to use it," he said. "That combination is good for homebuilders as well. That means you would have more of the move-up buyers selling their existing homes and moving to new homes, and they have the equity in their homes to do that.

That could be good news for top builders such as Toll Bros. (TOL), PulteGroup (PHM) and Lennar (LEN).

Celia Chen, a senior director at Moody's Analytics covering housing, said via email: "To the extent that an increase in home equity signals a better economy (and a) better housing market, this would suggest homebuilding will increase. But the connection is pretty loose.

The NAHB Remodeling Market Index hit the high-water mark of 57 in the third quarter. It's the sixth straight quarter above 50. A reading over 50 means more remodelers say market activity has risen from a quarter ago than say it has fallen.

Still, remodeling activity was hurt by the harsh winter weather in the first quarter and has never overcome that "dismal start to the year" in terms of total expenditures for the year, Melman says.

The NAHB said in a recent announcement that it expects 2014 residential remodeling to slip 3.4% from a year earlier, "due in large part to slow activity in the first quarter." It sees a 2.7% increase in 2015 and 1.3% rise in 2016.

Still, Fears expects HELOC originations to keep rising, which should bode well for home-remodeling activity.

"We are going to see the rate of home price appreciation slow (from) the double-digit growth of last year," he said. "But we will continue to see growth (in prices), and as interest rates rise, people won't want to refinance to tap the equity (in their homes). And that will make the HELOCs much more attractive to make home renovations."