Why high interest rates make it tough to tap home equity

Home equity is near all-time highs. But tapping it may be tough due to high interest rates, according to financial advisors.

Total home equity for U.S. mortgage holders rose to more than $17 trillion in the first quarter of 2024, just shy of the record set in the third quarter of 2023, according to new data from CoreLogic.

Average equity per borrower increased by $28,000 — to about $305,000 total — from a year earlier, according to CoreLogic. Chief Economist Selma Hepp said that’s up almost 70% from $182,000 before the Covid-19 pandemic.

About 60% of homeowners have a mortgage. Their equity equals the home’s value minus outstanding debt. Total home equity for U.S. homeowners with and without a mortgage is $34 trillion.

The jump in home equity is largely due to a runup in home prices, Hepp said.

Many people also refinanced their mortgage earlier in the pandemic when interest rates were “really, really low,” perhaps allowing them to pay down their debt faster, she said.

“For the people who owned their homes at least four or five years ago, on paper they’re feeling fat and happy,” said Lee Baker, founder, owner and president of Apex Financial Services in Atlanta.

Baker, a certified financial planner and a member of CNBC’s Advisor Council, and other financial advisors said accessing that wealth is complicated by high borrowing costs, however.

“Some options that may have been attractive two years ago are not attractive now because interest rates have increased so much,” said CFP Kamila Elliott, co-founder of Collective Wealth Partners and also a member of CNBC’s Advisor Council.

That said, there may be some instances in which it makes sense, advisors said. Here are a few options.

A home equity line of credit, or HELOC, is typically the most common way to tap housing wealth, Hepp said.

A HELOC lets homeowners borrow against their home equity, generally for a set term. Borrowers pay interest on the outstanding balance.

The average HELOC has a 9.2% interest rate, according to Bankrate data as of June 6. Rates are variable, meaning they can change unlike with fixed-rate debt. (Homeowners can also consider a home equity loan, which generally carries fixed rates.)

For comparison, rates on a 30-year fixed-rate mortgage are around 7%, according to Freddie Mac.

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While HELOC rates are high compared with the typical mortgage, they are much lower than credit card rates, Elliott said. Credit card holders with an account balance have an average interest rate of about 23%, according to Federal Reserve data.

Borrowers can generally tap up to 85% of their home value minus outstanding debt, according to Bank of America.

Homeowners can leverage a HELOC to pay off their outstanding high-interest credit card debt, Elliott said. However, they must have a “very targeted plan” to pay off the HELOC as soon as possible, ideally within a year or two, she added.

In other words, don’t just make the minimum monthly debt payment — which might be tempting because those minimum payments would likely be lower than those on a credit card, she said.

Similarly, homeowners who need to make home repairs or improvements can tap a HELOC instead of using a credit card, Elliott explained. There may be an added benefit for doing so: Those who itemize their taxes may be able to deduct their loan interest on their tax returns, she added.

A reverse mortgage is a way for older Americans to tap their home equity.

Like a HELOC, a reverse mortgage is a loan against your home equity. However, borrowers don’t pay down the loan each month: The balance grows over time with accrued interest and fees.

A reverse mortgage is likely best for people who have much of their wealth tied up in their home, advisors said.

“If you were late getting the ball rolling on retirement [savings], it’s another potential source of retirement income,” Baker said.

A home equity conversion mortgage (HECM) is the most common type of reverse mortgage, according to the Consumer Financial Protection Bureau. It’s available to homeowners who are 62 and older.

A reverse mortgage is available as a lump sum, line of credit or monthly installment. It’s a non-recourse loan: If you take steps like paying property taxes and maintenance expenses, and using the home as your primary residence, you can stay in the house as long as you like.

Borrowers can generally tap up to 60% of their home equity.

The homeowners or their heirs will eventually have to pay back the loan, usually by selling the home, according to the CFPB.

While reverse mortgages generally leave less of an inheritance for heirs, that shouldn’t necessarily be considered a financial loss for them: Absent a reverse mortgage, those heirs may have been paying out of pocket to help subsidize the borrower’s retirement income anyway, Elliott said.

Historically, the biggest advantage of having home equity was amassing more money to put into a future home, Hepp said.

“That’s historically how people have been able to move up in the housing ladder,” she said.

But homeowners carrying a low fixed-rate mortgage may feel locked into their current home due to the relatively high rates that would accompany a new loan for a new house.

Moving and downsizing remains an option but “that math doesn’t really work in their favor,” Baker said.

“Not only has their home gone up in value, but so has everything else in the general vicinity,” he added. “If you’re trying to find something new, you can’t do a whole lot with it.”

A cash-out refinance is another option, though should be considered more of a last resort, Elliott said.

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

A cash-out refi replaces your existing mortgage with a new, larger one. The borrower would pocket the difference as a lump sum.

To give a simple example: let’s say a borrower has a home worth $500,000 and an outstanding $300,000 mortgage. They might refinance for a $400,000 mortgage and receive the $100,000 difference as cash.

Of course, they’d likely be refinancing at a higher interest rate, meaning their monthly payments would likely be much higher than their existing mortgage, Elliott said.

“Really crunch the numbers,” Baker said of homeowners’ options. “Because you’re encumbering the roof over your head. And that can be a precarious situation.”