HELOC usage increased as payout refis decreased
Over the past year, as mortgage rates climbed higher, access to home equity through the receipt of cash during refinancing — a so-called cash-out refi — became less attractive.
Mortgage rates rose from just under 3% in early 2022 to a peak of over 7% in the fall. According to Mortgage News Daily, the average rate for a 30-year fixed-rate mortgage is currently 6.21%.
As cash-out refis fell, HELOC usage began to increase. According to CoreLogic, lenders issued a total of $214 billion in HELOCs last year through September, up from $159.5 billion for the same period in 2021.
“In a low interest rate environment, people have been looking for cash-out refis,” Bellas said. “Well … a lot of people have a mortgage with a very low interest rate, so they would pay for a payout refi [a higher rate] on their full mortgage.”
“We’ve had quite a few people over the past 12 months … who have chosen to go with the HELOC because of this,” Bellas said.
How HELOCs compare to other rental options
In general, HELOCs have low closing costs compared to mortgages or home equity loans, which function like other fixed-rate loans with a fixed repayment period. And if you have good credit, the interest rate you can get may be lower than what you would pay on a personal loan or credit card balance.
Currently, rates for HELOCs are 7.75% according to Bankrate. This compares to personal loan rates of over 10% for consumers with good credit and about 20% for credit cards, according to CreditCards.com.
I wouldn’t use a HELOC to buy frivolous things or things you can’t afford.
David Demming
President of Demming Financial Services
However, like your mortgage, a HELOC is a lien on your home — meaning the lender would have the right to mortgage your home if you don’t pay it back as promised.
“I wouldn’t use a HELOC to buy reckless things or things you can’t afford,” said board-certified financial planner David Demming, president of Demming Financial Services in Aurora, Ohio.
“It should be a short-term bill that you’re going to pay off within a limited amount of time,” Demming said.
Here are three important things to consider before signing on the dotted line.
1. Variable interest rates make budgeting difficult
The interest rate on HELOCs is typically floating, meaning it moves up and down based on the so-called prime rate, which banks use as a basis for setting interest rates on a variety of loans. While the Federal Reserve doesn’t control the federal funds rate, it does pull the one it influences – the banks’ federal funds rate.
“Because it’s variable, it can be difficult to budget from month to month,” Bellas said.
At the moment, the US is in an environment of rising interest rates, although this is likely to change over time. The Fed’s rate-setting committee is meeting this week and is expected to hike the federal funds rate by a quarter of a point, meaning the federal funds rate will generally tick higher — as will HELOC rates.
2. It can be difficult to repay the principal
HELOCs typically come with monthly interest payments only — meaning none of your minimum payments go toward principal.
“Unless you have a lot of excess funds and you’re only making interest payments, it can be difficult to find the money and discipline to pay off that balance,” Bellas said.
“I’ve seen people with $50,000 in credit and five years later it’s still close [amount],” he said.
HELOCs generally have a “draw period” in which you can withdraw money, which often lasts 10 years, and then a payback period of say 10 or 20 years when you start paying both interest and principal. And because of this, your payments will skyrocket if you’ve only been paying interest.
For example, according to InvestorsBank.com’s HELOC calculator, a $50,000 balance would yield only $312.50 in interest payments and then grow to $593.51 over a 10-year repayment period.
If your HELOC has a balance when you sell the home, it must be paid off along with the main mortgage on the home.
3. Beware of transferring debt to a HELOC
Sometimes homeowners turn to a HELOC to pay off higher-interest debt, such as a mortgage. B. credit card balance to settle.
At first glance, it might make sense to move high-yield balances to a HELOC. However, if you don’t have a plan to pay off the HELOC, you’re only delaying the inevitable, Bellas said.
“The real danger is that you recategorize the debt and kick it out into the street,” Bellas said. “There’s probably a bigger issue that needs to be addressed.”
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