More Homeowners Are Tapping Their Home Equity

The Wall Street Journal

Homeowners are treating their castles like cash registers again.

Borrowers took out about 230,200 home-equity lines of credit in the first quarter, up 9% from a year prior, letting them tap up to $23.4 billion, the highest quarterly amount since 2008. The average credit line in March was $100,207, up 4% from a year earlier and the highest since 2008, according to credit-reporting company Equifax.

Lenders are luring homeowners by charging lower interest. Home-equity lines of credit, which are commonly known as Helocs and which account for most home-equity lending, had an average rate of 5.01% in June, down from 5.16% a year earlier, according to mortgage-information website Rates on new home-equity loans also have fallen.

The most common reason borrowers give for taking out loans and lines of credit is to pay for renovations. Others use them to cover emergency expenses.

Terri Ivey and her husband, David, signed up for a $50,000 home-equity line of credit in May, so they would have a source of funding in an emergency after emptying their savings accounts to cover a large tax bill from selling a separate rental property they owned.

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The Iveys, who live in Lexington, S.C., haven't tapped the line of credit so far, but Ms. Ivey, 58 years old, says she feels more comfortable knowing it is there if she needs it. "You need an emergency fund that you can go to until you build up liquid savings again," she says. "We're keeping this there just in case."

Still other homeowners use the money to pay off credit-card debt or personal loans, according to banks and borrowers. That can be a savvy move, because the interest rates on home-equity products often are lower than on other loans.

But missteps can be perilous. If you default on credit-card debt or a personal loan, the consequences are likely to be less severe than if you default on a home-equity loan or line of credit, which can, in a worst-case scenario, cost you the roof over your head.

Some home buyers are using loans and lines of credit to buy new homes. By combining a mortgage with a line of credit, for example—an arrangement known as a piggyback mortgage—borrowers can avoid fees associated with low down payments and may be able to afford a more expensive home.

But tapping loans and lines of credit can reduce a homeowner's equity and present significant risks. Perhaps the greatest danger is that a drop in housing prices could leave homeowners owing more money on their properties than they would be able to sell them for in a pinch. Normally, the down payment and any paid-off principal provide a cushion.

The number of homeowners who owed more on their mortgages than their homes were worth peaked in 2009 during the housing crisis, and it was a major factor causing foreclosures to spike. Many people who lost their jobs, for example, could neither make their monthly mortgage and loan payments nor sell their homes for enough to cover their mortgages.

As foreclosures mounted and home values declined, many lenders stopped originating home-equity loans and lines of credit, and others scaled back their offerings. But the recent run-up in home prices, a rebounding economy and a slowdown in mortgage refinancing have pushed banks to pursue other forms of lending, including home-equity lending once again.

With home-equity loans, borrowers receive a lump sum of cash in their bank account that is equal to the loan amount and they must start paying interest immediately. With lines of credit, borrowers can draw down the line little by little or all at once, and only pay interest on the amount they borrow.

The money can prove helpful, if used wisely. For example, homeowners who use the funds to upgrade their kitchen or build an additional bedroom can end up with a house that is worth more, even after accounting for borrowing costs.

Before signing up, borrowers should make a realistic assessment of how much they can afford to borrow. Many lenders are allowing homeowners to borrow a greater amount of their home's value, which could put them at risk even if home values drop by a relatively small amount.

For example, in January, Vienna, Va.-based Navy Federal Credit Union, the largest U.S. credit union, began allowing homeowners to borrow up to all of their equity with home-equity loans.

That same month, Flagstar Bank, a unit of Troy, Mich.-based Flagstar Bancorp and the eighth-largest U.S. mortgage lender, began allowing borrowers to take out up to 90% of their home's value with home-equity loans or lines of credit, up from 80%.

Borrowers also should consider whether they can handle spikes in their monthly payments. Many lenders offer interest-only home-equity lines of credit that allow borrowers to pay only interest charges, often for up to 10 years, before principal payments are due.

Assuming prices rise, these borrowers could repay the principal upon selling their home. But spikes in monthly payments can be tough to manage. The delinquency rate on home-equity lines of credit taken out in 2004, many of whose interest-only periods came to an end this year, increased to 5.3% in June, compared with 4.0% in December, according to Equifax.

Borrowers also need to consider interest-rate changes. Home-equity lines of credit typically come with adjustable, rather than fixed, interest rates, and those rates can change monthly, which could result in higher monthly payments should interest rates rise. To lessen the potential shock, borrowers may want to consider home-equity loans, which typically come with fixed interest rates.

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