Soaring real estate prices during the Covid-19 pandemic have left American homeowners sitting on nearly $28 trillion of equity, according to a tally by the Federal Reserve.
And, while the the pace of home-price increases has slowed, no major housing forecaster predicts we'll see retreats when comparing the median U.S. sale price to the same month a year earlier – the gauge used by economists.
Home equity, the difference between the value of homes and the mortgages financing them, has increased about $8 trillion just since the start of the pandemic in March 2020, according to the Fed data.
The surge in real estate prices boosted values even for homeowners who didn't put their property on the market. Appraisers gauge home value using “comparable sales,” meaning the sale price of similar homes in a neighborhood. So, the biggest real estate boom on record lifted the worth of all homes, not just the ones that sold.
While some Americans will decide to leave that increase in housing wealth untapped, as part of a long-term strategy to save, for example, for retirement, others are using it for renovations, education or paying off debts. Rates for home equity loans are about a third the rates charged by credit card companies, and the interest on equity loans in some cases can be a tax-deductible.
How to Choose the Right Home Equity Loan
Higher home values gives consumers more flexibility because banks or mortgage lenders are able to offer larger amounts for cash-out refinances, home equity loans and home equity lines of credit (HELOCs). Most lenders require borrowers to leave a 20% equity buffer in a property.
The advantage of a HELOC is that it works like a credit card, with lower rates. The average HELOC rate, which typically is adjustable on a set schedule, currently is 4.27%, while the average credit card rate is about 16%, according to Bankrate. Rates for HELOCs are typically quotes as a margin added to the prime rate that banks charge their most creditworthy customers. A typical rate would be expressed as: “Prime plus 1%.”
A HELOC is the “most cost-effective way to have access to the equity in the home,” said Craig Garcia, president of Capital Partners Mortgage in Coral Springs, Florida.
Since a HELOC is considered a second lien against your house or condo, the interest rate will be higher than the rates being offered for the main mortgage because it means greater risk for lenders, Garcia said.
Fixed-Rate Home Equity Loans
Some homeowners prefer a fixed-rate home equity loan that is borrowed in one chunk, since it gives you more control on the interest rates. But, you pay interest on the funds even if they haven’t been paid out to your home renovator or used for education.
Fixed rates help consumers to budget more easily, said Garcia. The lump-sum home equity loans loans usually have terms from five to 20 years.
This might be a preferred option for homeowners who managed to snag the ultra-low rates seen in 2020 and 2021, he said, because it doesn't require replacing your main mortgage with a new loan.
“It’s likely you leave your first mortgage rate intact, which is very likely pretty low versus the current market available rate,” he said.
Whether you pick a home equity loan or a HELOC, lenders require you to pay closing costs and fees similar to a traditional mortgage. Closing costs range between 2% and 4% on the price of a property.
When a Cash-Out Refi Is Helpful
The third option is to obtain a cash-out refinance, where homeowners take out a new and bigger mortgage on their existing home, with the bonus of getting a check at closing.
A cash-out refi means resetting the term of a mortgage, so you’ll be adding years to the time you’ll be paying interest.
"You could be increasing your overall borrowing costs going this direction,” said Garcia.
Watch Home Values
Home-price gains have started to slow, according to a report from S&P CoreLogic Case-Shiller Indices last month. The annualized gain was nearly 20% in May, slowing from April’s 21% pace.
All the major housing forecasters, including Fannie Mae, Freddie Mac, the Mortgage Bankers Association, and the National Association of Realtors, predict home prices will continue to gain – albeit it a slower pace.
Home prices likely will gain 12% this year, a slower pace than the record 18% spike in 2021, according to a forecast from the National Association of Realtors. Next year, the pace likely will slow to 2.1%, which is about half of the average annual gain seen over the last four decades, according to NAR data.
Measured quarterly, home prices likely will increase 12% in the current three-month period, from a year earlier, and slow to a 1.6% annualized gain by the fourth quarter, NAR said.
While home prices may fluctuate month to month, as happens during a typical annual real estate cycle, it’s unlikely there will be a decline in the monthly national median price compared to a year earlier, Lawrence Yun, NAR’s chief economist, told the U.S. Senate in testimony last month. Bigger homes tend to sell in the spring and summer so families with children can move before the start of school in September, leaving smaller properties to sell in the fall and winter.
“I do not foresee a national home price decline, but some local markets may pull back somewhat from the record-high home prices,” Yun said in his testimony.
Don't Miss: If you want to learn more about tapping into your home’s equity without taking out a second mortgage, talk to a Home Loan Expert who can help you understand the home equity and refinancing options that are available to you.