Why high interest rates make it harder to leverage your home equity

Home equity is nearing record levels, but high interest rates mean it could be hard to tap into that wealth, financial advisers say.

Total home equity for U.S. mortgage holders is expected to exceed $17 trillion in the first quarter of 2024, just shy of the record set in the third quarter of 2023, according to the latest data from CoreLogic.

Average equity per borrower rose by $28,000 from a year ago to a total of about $305,000, according to CoreLogic. That’s up about 70% from the $182,000 before the pandemic, said chief economist Selma Hepp.

About 60% of homeowners have a mortgage. Homeowner equity is equal to the value of their home minus any outstanding debt. Total home equity for U.S. homeowners, with or without a mortgage, is $34 trillion.

Hepp said the increase in home equity was mainly due to rising home prices.

Many people also refinanced their mortgages early in the pandemic when interest rates were “very low,” likely allowing them to pay off their debts faster, she said.

“People who owned homes at least four or five years ago are wealthier and happier on paper,” said Lee Baker, founder, owner and president of Apex Financial Services in Atlanta.

But Baker, a certified financial planner and member of CNBC’s Council of Advisors, and other financial advisers said access to that wealth is complicated by high borrowing costs.

“Options that were attractive two years ago are no longer attractive now because interest rates have risen so much,” said Camilla Elliott, CFP, co-founder of Collective Wealth Partners and a member of CNBC’s Advisor Council.

But there are cases where it makes sense, advisers say. Here are some options:

Hepp said a home equity loan, or HELOC, is typically the most common way to tap into home equity.

A HELOC allows homeowners to borrow money, usually against their home equity, for a set period of time. The borrower pays interest on the outstanding balance.

According to data from Bankrate as of June 6, the average interest rate on a HELOC is 9.2%. The interest rate is variable, which means it can change unlike fixed-rate debt. (Homeowners can generally also consider a fixed-rate mortgage.)

By comparison, the interest rate on a 30-year fixed-rate mortgage is about 7%, according to Freddie Mac.

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Elliott said that while HELOC interest rates are higher than a typical mortgage, they are still much lower than credit card interest rates: The average interest rate for credit card holders with account balances is about 23%, according to Federal Reserve data.

According to Bank of America, borrowers can typically borrow up to 85% of their home’s value, minus any outstanding debt.

Elliott said homeowners can use a HELOC to pay off outstanding high-interest credit card debt, but added that it takes a “very targeted plan” to pay off the HELOC as quickly as possible, ideally within a year or two.

In other words, don’t just pay the minimum payment each month, as tempting as it may be, because the minimum payment is likely to be lower than what you’d pay on a credit card, she says.

Similarly, homeowners who need to make repairs or renovations to their home can take out a HELOC instead of using a credit card, Elliott explained. Doing so could have an added benefit: People who itemize their taxes may be able to deduct the interest on the loan on their tax return, she added.

Reverse mortgages are a way for older Americans to tap into the equity in their homes.

Like a HELOC, a reverse mortgage is a loan secured by the equity in your home, except that instead of borrowers making monthly payments on the loan, the balance grows over time as interest and fees accrue.

Advisers say reverse mortgages are likely to be best suited for people who have a lot of their equity invested in their home.

“If you start moving towards retirement too late, [savings]”This is another potential source of retirement income,” Baker said.

According to the Consumer Financial Protection Bureau, a Home Equity Conversion Mortgage (HECM) is the most common type of reverse mortgage. It is available to homeowners who are 62 or older.

A reverse mortgage can be paid in a lump sum, a line of credit, or monthly installments. It’s a non-recourse loan. You can continue to live in your home for as long as you like, as long as you pay property taxes, maintenance fees, and use the home as your primary residence.

Borrowers can typically use up to 60% of their home’s equity.

The homeowner or their heirs must eventually repay the loan, usually by selling the home, according to the CFPB.

Although reverse mortgages generally leave heirs with less assets, that shouldn’t necessarily be viewed as a financial loss to the heirs: Even without a reverse mortgage, the heirs could have paid out of their own pockets to supplement the borrower’s retirement income, Elliott said.

Historically, the biggest benefit of having home equity has been the ability to save more money for a future home purchase, Hepp said.

“Historically, that’s how people moved up the housing price ladder,” she said.

However, homeowners with low interest rates and fixed-rate mortgages may feel locked into their current homes because of the relatively high interest rates associated with a new loan for a new home.

Moving or downsizing remain options, but “the math doesn’t really work in their favor,” Baker said.

“Not only has their home gone up in value, but everything else around there has gone up in value,” he added. “Trying to find something new isn’t going to help much.”

Elliott said cash-out refinancing is an option, but should be considered a last resort.

“Right now, I don’t know anyone who’s recommending a cash-out refinance,” she said.

A cash-out refinance replaces an existing mortgage with a new, larger mortgage. The borrower receives the difference in a lump sum.

To give a simple example, say a borrower owns a home worth $500,000 and has a mortgage of $300,000, the borrower can refinance the mortgage to $400,000 and receive the $100,000 difference in cash.

Of course, you’ll likely be refinancing at a higher interest rate, so your monthly payments will likely be much higher than your existing mortgage, Elliott said.

“Really crunch the numbers,” Baker said of homeowners’ options, “because you’re putting a strain on the roof over your head. And it can be a dangerous situation.”