Americans are awash in record amounts of equity in their homes, posing the question for millions: So what do we do with it?
Leave it for a rainy day or retirement? Tap into it to remodel the house? Make a down payment on a vacation condo?
These are crucial financial decisions, but the abundance of equity is giving large numbers of owners options they didn't have before.
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▪ According to the latest Federal Reserve estimates, homeowners control more than $14.4 trillion in equity, up by nearly $1 trillion during 2017. This explosive growth is being driven by increases in home values and selling prices, tight inventories of houses for sale, and pay-downs of principal on existing mortgages.
▪ As a practical matter, not all of this can be turned into spendable cash. Only roughly $5.4 trillion is "tappable," according to data analytics and software firm Black Knight. That is, it could be extracted by owners using loan types that require borrowers to retain at least 20 percent equity after a transaction. To illustrate, say you own a $400,000 house with a $200,000 first mortgage balance. You've got $200,000 in equity, putting aside transaction costs.
You'd like to transform some of it into cash to invest in a new business venture. How much can you get? Most lenders require that the total mortgage indebtedness secured by your home not exceed 80 percent of the property's value -- $320,000 in this case. So assuming that you qualify on credit and other criteria, you might be able to pull out up to $120,000 from your equity.
There are three main ways you can consider to accomplish this:
▪ Home-equity line of credit. This is a credit line secured by your home equity that allows you to withdraw amounts you need whenever you choose. Typically, HELOCs come with floating interest rates tied to an index, often the bank prime rate. You pay interest-only for a pre-set period, at which point your outstanding balance comes due. Or the HELOC morphs into full amortization mode, requiring payments of principal plus interest.
Here's an example of current HELOC terms from an active lender, TD Bank. Your house is valued at $400,000, you've got a $200,000 balance on a first mortgage at 3.25 percent that you snagged when rates were near historic lows. Assuming you've got solid credit, you might qualify for a $100,000 HELOC at an annual percentage rate (APR) of 3.99 percent, with monthly interest-only payments of $327.95.
Looks good. But there are complications: If you want to use that $100,000 for anything other than home improvement or purchase, your interest payments won't be deductible under new tax rules. Plus, with the Federal Reserve planning to ratchet up interest rates, your interest costs likely will increase.
▪ Cash-out refinancing. This involves replacing your current first mortgage with a larger one, allowing you to pocket the additional funds. A downside here: The loan you exchange your precious 3.25 percent rate for is likely to cost at least one percentage point more than your current loan. And you should check with your tax adviser on what precisely may be deductible if your new total debt exceeds the amount of your original mortgage.
Here's an example of a $100,000 cash-out refi using the same scenario above, provided by Paul Skeens, president of Colonial Mortgage Group in Waldorf, Maryland: Your new mortgage amount on your $400,000 home will be $300,000, with a new fixed-mortgage rate for 30 years at 4.375 percent, plus half a point (.5 percent of the loan amount). Your monthly payment comes to $1,497.86.
Skeens says in the present rising-rate environment, most of his clients are opting for the fixed-rate cash-out refi instead of a HELOC. But Freddie Mac deputy chief economist Len Kiefer says both cash-outs and HELOCs are likely to grow in popularity -- the key difference being the rate owners have on their current mortgage.
▪ Home-equity loan. These are traditional second mortgages and come with fully amortizing fixed rates currently in the low and mid 5-percent range and higher, depending on your credit. TD Bank, for example, quotes a rate of 5.31 percent APR for 15 years with a payment of $805.98 for the same $100,000 deal discussed above. Some lenders offer more generous qualifying terms than HELOCs but have the same tax restrictions if you want to deduct the interest.
Bottom line: If you're among the newly equity-affluent Americans, check out your options with lenders. Or just sit tight and enjoy the ride.