Should You Spend Your New-Found Equity?
Millions of homeowners may not realize how much equity their homes have recovered during the past three years of housing recovery. Over the course of the recovery rising sale prices have increased home values, even for homes that have not been sold. Higher home values coupled with the monthly mortgage payments have been increasing the stake that owners own in their homes, also known as their equity.
Not every owner has seen all his lost equity restored, though. By September, only 170 of the nation’s largest 300 markets, or 57 percent, had achieved full price recovery. These markets include 53 of the top 100 markets, according to Homes.com’s monthly Rebound Report. Some homes, markets, and regions will take longer than others to return to their 2007 price levels.While it may be slow, though, progress in restoring equity has been steady. The total number of mortgaged residential properties with negative equity—where owners owe more on their mortgages than their homes are worth–stood at 4.1 million, or 8.1 percent, in the third quarter of 2015. That was down 4.7 percent quarter over quarter from 4.3 million homes, or 8.7 percent, compared with the second quarter and down 20.7 percent year over year from 5.2 million homes, or 10.4 percent, compared with Q3 2014, according to CoreLogic.
If you are one of the luckier owners who has reached your past peak value or more, you can access your home equity one of three ways. Firstly, when a house sells, the owner’s equity is the amount remaining after the balance of the mortgage is paid off. A second option is refinancing, where owners take out a new mortgage and access some of their equity by borrowing more than they owed on their old mortgage. Finally, many lenders allow homeowners to use their equity as collateral for certain types of loans, such as home equity lines of credit (HELOCs) or second mortgages. Second mortgages are popular with homeowners who want to access more equity by don’t want to refinance their primary mortgage at a higher rate of interest.
There are advantages and disadvantages to tapping into your equity. During the housing crash in 2007 and 2008, homeowners who had borrowed against the value of their homes with HELOCs found that when their homes lost value, they were still on the hook for the loans that they had taken out. Many of these are still paying off their HELOCs. Others who had refinanced had no equity cushion and were vulnerable to default and foreclosure if they were laid off or had other financial problems. Before 2007, the housing market had appreciated steadily every year; not since the Great Depression had it crashed as it did in 2007-2009. Thousands of homeowners who thought their homes would steadily gain value year after year and spent or borrowed against their equity found themselves homeless, which is one reason most lenders require borrowers to retain at least 20 percent of their equity when refinancing.
On the other hand, accessing your equity and putting it to good use may be a prudent decision. The primary reason most homeowners refinance is to pay for remodeling and repairs to their homes. With the economy strengthening and house prices recovering, spending by owners on discretionary home improvements rose by almost $6 billion between 2011 and 2013. Even more significantly, the share of spending on discretionary projects increased for the first time since 2005 according to the Joint Center for Housing Studies. These projects increased home values, make houses more attractive to future buyers and improved owners’ quality of life.
Another popular use of equity is debt consolidation. Owners borrow against their equity at low rates of interest—as low as mortgage rates if they refinance—in order to pay off credit card and consumer debt at much higher rates. While they still have the same amount of debt, they end up paying considerably less interest.
A third use for equity is college tuition. The cost of college has skyrocketed in the past 25 years, resulting in the percentage of all U.S. households with student loan debt increasing from 9 percent in 1989 to 20 percent in 2013. The median amount of student debt among these households simultaneously increased, in real terms, from $5,423 in 1989 to $17,000 in 2013, according to the Harvard Joint Center for Housing Studies. Parents can relieve their children of some or even all of the cost of their college education by cashing out on some of their home equity or borrowing against their home equity, often at lower interest rates available through many student loan programs, including the federal government’s PLUS program.
When it comes to spending, many homeowners have learned the hard way that it’s not wise to blow through home equity as if they have won the lottery. On the other hand, when you’ve restored the equity you lost in the housing crash, prudent use of your equity can reap dividends in many ways.