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Homeowners have seen the equity in their homes reach historic levels this year, according to recent studies.
But rising interest rates have discouraged most borrowers from using cash-out refinances to access these funds. Instead, lenders have seen customers turning to home equity loans and lines of credit.
“Because of interest rates going up, people didn’t want to refinance out of a first mortgage that was at an extremely low rate,” said Stephen Lewis, president and CEO of Thomaston Savings Bank. “So, the home equity loan became the next best alternative where they could access their equity in their home as they needed it, and they wouldn’t have to pay off a really low-rate first mortgage.”
The historically low interest rates in 2020 and 2021 have left 73 percent of homeowners nationwide with a mortgage rate below 4 percent, according to John Burns Real Estate Consulting.
Some of the traditional reasons borrowers open HELOCs include house repairs and debt consolidation. With more rate hikes expected as the Federal Reserve attempts to bring down inflation, HELOCs could become a key resource as borrowers look for ways to manage expenses and finances.
Remember Them?
HELOCs provide homeowners with access to a line of credit, similar to a credit card. Not everyone who applies for a HELOC ends up accessing funds, Lewis said, with some just wanting to have access to money in case of an emergency.
The products usually come with an introductory rate for a period followed by a variable rate. During the period when homeowners can draw funds, only interest and fees need to be repaid.
Connecticut saw 8,690 home equity loans or lines of credit issued in the first seven months of 2022, up 55 percent over the same period in 2021, according to The Warren Group, publisher of The Commercial Record. Refinances during that period dropped 46 percent year-over-year.
When low rates continued to spur the refinance boom in 2021, Connecticut saw 10,798 home equity loans and lines of credit issued over the entire year. The last time lenders saw higher mortgage rates lead to a spike in HELOCs was 2018, when Connecticut had more than 23,400 of these loans.
But the situation facing borrowers today is different from 2018.
“Home equity per homeowner is much higher than it was back then,” said Eric Finnigan, vice president of research and demographics at John Burns Real Estate Consulting.
Across most of Connecticut, homeowners had a total of $115.36 billion in tappable home equity in July, according to Black Knight, a mortgage technology and data provider. That amount has increased since the first quarter of 2022, when the state’s core-based statistical areas had $99.5 billion in tappable equity. The amount excludes Windham County, which is part of a metropolitan statistical area centered on Worcester, Massachusetts.
The current rising rate environment also has more homeowners who recently refinanced compared to 2018, Finnigan added.
“I think we’re in a particularly interesting time in history right now just because of the record-high home equity levels and because of all those homeowners that hold very low mortgage rates that are likely to stay in homes much longer and turn to remodeling rather than moving,” said Matt Saunders, John Burns Real Estate Consulting’s senior vice president of building products research.
Money Useful for Remodeling
Lenders have traditionally seen home repairs and renovations among the top reasons for customers to seek HELOCs. Finnigan said his research has already shown an increase in HELOCs being used nationwide to fund remodeling projects.
With first mortgages locked in at record low rates likely keeping many borrowers in their homes, Saunders said, the housing stock has also reached a point where many homes will be at a prime remodeling age, spurring more home improvement projects.
The higher levels of home equity could help homeowners keep their first mortgage and use HELOCs to pay for larger projects that typically would have been funded with cash-out refinances, Saunders said. He added that research has shown that rather than smaller do-it-yourself tasks, larger projects have been driving remodeling activity this year.
Even with the trend toward HELOCs, some larger projects could end up benefiting from a cash-out refinance, Saunders said.
“I do think as rates rise, it’s going to increase the cost of borrowing associated with those variable rates [on HELOCs],” Saunders said. “So, there’s not going to be a complete substitution from the refis to the HELOCs; there’s going to be some associated cost of financing weighing on those larger remodels.”
HELOCs have also been used instead of construction loans because of the flexibility they provide if a project sees the costs go overbudget or encounters supply chain issues, said Lewis, Thomaston Savings Bank’s president and CEO.
Thomaston Savings Bank did not see much HELOC activity amid the refinance boom, but the bank had anticipated that volumes would increase this year, Lewis said. The bank put retail staff through training to prepare for increased activity.
“Everybody had to get a little refresher on system and process,” Lewis said.
In addition to home repairs and remodeling, another key driver of HELOC activity has been debt consolidation, Lewis said. While a HELOC could be structured in a way that rates end up being between 5 percent and 6 percent, Lewis said, credit card rates now often exceed 20 percent.
“People know that that rate is just going to continue to go up,” Lewis said. “People look at that credit card debt, how much they’re paying in interest, … and are paying off credit card debt, which is historically what people have done when they’ve done a home equity loan or a refinance.”
