The increase is eye-opening in part because last year’s changes in federal tax law were seen as a major negative for home-equity borrowing. The law removed interest deductibility for home-equity loan balances — new and existing — that are not used to renovate, build or acquire a home. The loss of deductibility made tapping home equity more expensive on an after-tax basis for many borrowers.
But owners apparently haven’t been deterred. Not only have new borrowings for HELOCs risen sharply this year, but another form of equity-tapping — cash-out refinancings — has hit its highest level since the housing boom. In a cash-out refi, a homeowner pays off an existing mortgage and replaces it with a new, larger loan. The owner can pocket the difference, tax-free, and spend the money on whatever he or she chooses.
In the first quarter of this year, 68 percent of all refinancings at investor Freddie Mac involved cash-outs. Although total volumes of refinancings are down significantly, cash-outs are at their highest percentage since the fourth quarter of 2007, just before the crash.
Are the sizable jumps in equity-tapping portents that we shouldn’t ignore? In the years immediately preceding the financial crisis, many homeowners used HELOCs like credit cards or ATMs — hocking their inflated property values to finance boats, autos, even daily living expenses — until the game ended. Home prices sagged and crashed; owners’ equity holdings turned to vapor.
Some economists have worries, but most point out that today’s market and regulatory conditions are markedly different. Most banks now require borrowers to have relatively high credit scores and a cushion of equity — generally 20 percent of the estimated home value — and to document everything. Back in the funny-money heydays of the boom, some lenders essentially required no equity and no documentation — even negative equity was occasionally okay. Today’s credit scores, by contrast, according to Amy Crews Cutts, chief economist for Equifax, are high: A median 770 Vantage score for HELOCs and 713 for home-equity loans or second mortgages.
But there are concerns. Frank Nothaft, chief economist for CoreLogic, a real estate valuation and data analytics firm, notes that one-third of the largest metropolitan markets are now “overvalued”: There’s a mismatch between the frothy growth rate in median home prices compared with growth in per capita incomes. During the lead-up years to the crash, two-thirds of all metro markets were overvalued.
Nothaft suggests that although the country is not in a “valuation bubble,” there are “many urban areas where prices appear to have become de-linked to the long-term relationship with income” and thus affordability. That “raises the specter of a new bubble forming within the next few years,” he warns.
Sam Khater, chief economist for Freddie Mac, argues that fears about the fast growth in cash-out refinancings are misplaced. Although rising cash-out levels coincided with the boom years, he said in an interview, today they’re less meaningful because the number of refinancings has fallen dramatically in the past year as interest rates have increased. Most owners who have refinanced this year, he said, have not been seeking lower interest rates but rather equity extraction, raising the cash-out percentage.
Today’s owners appear to be making more responsible use of their home-equity borrowings. In a study of equity-loan requests on its network of banks and mortgage companies so far this year, LendingTree, the online shopping-comparison platform, found that 81.2 percent of owners said they plan to use the loan proceeds either for home improvements or debt consolidation. The latter can be a smart move because it allows the owner to pay off credit card bills and other high-cost debts with relatively low-cost home-equity dollars.
But remember this about home equity: It’s not money in the bank. It’s wealth that depends on market movements, and it can melt if the market turns.