Cash-strapped Americans are using their homes to pay down debt and outpace the rising cost of living.
The use of home equity lines of credit, a type of revolving loan that gained bad reputation for their role in the 2008 financial crisis, has been on the rise after hitting a post-crisis low two years ago. These products have long been popular as a way to finance home improvement projects, but these days mortgage lenders say many of the applications they receive are for debt consolidation.
“It’s gotten so much easier,” says Rochelle Adamson, a self-employed hairdresser, virtual assistant, and content creator. Last year, she consolidated more than $55,000 in debt across seven credit cards with a HELOC from a rental property.
“You can’t just take this card out and go to the store, so think about it a little more seriously,” she added. “It’s attached to your bank account. You have to log in. It’s connected to your home.”
The resurgence of HELOCs comes at a contradictory time for many homeowners’ finances. After years of high inflation, many homeowners are more in debt than ever. But their home equity is near an all-time high, averaging $315,000, according to data provider CoreLogic.
Read more: What is a HELOC? How do home equity lines of credit work?
Households held a total of about $35 trillion in equity in their homes as of the end of June, according to data from the Federal Reserve.
But as consumer home values rose, so did consumer debt. National credit card debt rose 5.8% from a year earlier to more than $1.14 trillion at the end of June, according to data from the New York Fed. Auto loan debt is also on the rise, totaling $1.63 trillion.
“People are really hurting,” said Sarah Rose, senior home equity manager at Affinity Federal Credit Union. “Credit cards, personal loans, the interest rates on those things are just astronomical. Consolidating that debt over 30 years to a lower interest rate is a win for a lot of people.”
The case for consolidating debt using a HELOC is relatively simple. HELOCs can have fixed or variable rates. It is usually the prime rate plus an additional amount known as a spread. Its connection to prime makes it one of the few types of loans whose interest rate adjusts immediately after the Fed changes its base rate.
According to Bankrate, interest rates vary depending on factors such as a customer’s credit score, but have recently averaged around 9%. This is higher than typical first mortgage rates, but for those with balances on credit cards, this calculation may be attractive. As of May, the average card interest rate was over 21%.
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Read more: HELOC vs. Home Equity Loan: Which is better when interest rates are higher?
Like a credit card, a HELOC is a type of revolving credit that allows customers to use the full amount approved, but they are not required to do so and can access the funds again after payment.
Customers typically have a set period of time (usually 5 to 10 years) in which they can use their HELOC, and in some cases, they only pay interest on the balance during that period. After the draw period ends, customers have a repayment period of up to 20 years.
For Adamson, who lives in Honolulu, Hawaii with her husband and daughter, the math made sense. Before my HELOC, I felt like my overall debt wasn’t decreasing even though my monthly credit card payments were $3,200. The interest rate on her card was 18% to 22%, while the HELOC ranged from 10% to 11.5%.
“Interest has a big impact on how much money you can pay back and how quickly,” she said.
She paid off about $20,000 in HELOC debt last year, after pausing more aggressive repayments to help rebuild a depleted emergency fund and taking additional withdrawals to cover other expenses. , I’m currently paying about $1,000 a month towards my balance.
There are reasons to be cautious about using a HELOC to pay off other debts. Finally, because a HELOC is secured by your home, in a worst-case scenario, the lender could foreclose on the property if the borrower defaults.
Additionally, in some cases, customers may be approved for a larger credit line than they need for debt consolidation, making it important to manage overall spending.
Jerica Espinosa, a financial planner with DMBA in Salt Lake City, Utah, believes her clients can live within their means and not be tempted to take on more debt. It states that it is recommended to use a HELOC as a debt consolidation tool only if. You will end up exceeding your loan limit more than necessary.
“HELOCs are like fire,” Espinosa said. “If suppressed and properly managed, they can help a person progress successfully. They can also get out of control and have a negative impact on one’s economic situation.”
HELOC usage is increasing, but it’s still a fraction of what it was during the financial crisis. Lenders extended more than $700 billion in credit lines in early 2009, but now have about $379 billion on their books. Many banks either exited the market or only offered credit facilities sporadically when interest rates were low.
Nonbank lender Achieve began offering fixed-rate HELOCs for debt consolidation purposes in 2019, a period when home values were rising, but few banks were active in this space. Ta. Kyle Enright, the company’s president of lending, said more conservative lending terms allow customers to use the line responsibly.
“None of our renters lost their homes,” Enright said. “Very few borrowers who took out HELOCs in the past five or six years have lost their homes. As long as lenders use reasonable underwriting standards, there is no significant risk to consumers. ”
Claire Boston is a senior reporter at Yahoo Finance covering housing, mortgages and home insurance.
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