House Values Are Going Up and Homeowners Are Choosing Home Equity Credit Lines and 2nd Mortgages for Cash Out

Home prices are rising across much of the US. Zillow reports the median value of a home was $216,000 in May 2018, which was 8% higher than a year ago. This is good news for home sellers, and also for home owners who want to pull cash out of their homes with a home equity line or home equity line of credit (HELOC).

For people who have a lot of home equity due to home appreciation in the current economic expansion, it is tempting to tap that equity to pay for big ticket items, such as paying down debt, buying a car or fixing up the home.

Many Americans are being tempted to grab that equity while they can. Consumer Reports states that originations of HELOCs were up 14% from a year ago in the first quarter of 2018. Borrowing on your home's equity is a fairly inexpensive way to do things such as finance a home improvement project. According to Bankrate, current HELOC rates are in the range of 6%, which is in line with the best personal loan rates that you can get from SoFi and Lending Tree. But to get the best personal loan rates, you need to have stellar credit. A HELOC does require decent credit, but the loan is secured by the home. The bank can afford to risk giving you a lower rate with a lower credit score in this case.

HELOCs have other advantages as well. Unlike a personal loan, you can borrow small amounts of money over time. This can keep your interest payments down. For example, say you get a HELOC with a credit line of $25,000, but you only need $10,000 of that amount to pay for your kitchen renovation. You only will pay interest on the $10,000 that you use and can leave the $15,000 as a reserve for other expenses.

A HELOC also has a longer repayment period than a personal loan, typically 30 years vs. 10 years. This will keep your interest payments lower, but you also will pay higher interest over time. Also, a HELOC is much less expensive in many cases than a credit card. As the US economy has improved, interest rates on credit cards are often above 20%.

While home equity lines of credit can be an effective tool for your finances, it is also easy to get in trouble with them. Many homeowners who pulled out equity during the Great Recession with a HELOC found that they could not make the payments when the interest rates went up. A HELOC has a low rate at first that is fixed, but it can go up over time. Also, during the housing meltdown, house values plunged. This resulted in people owing more on their home that it was worth.

Also, it is easy to abuse a home equity line of credit. It often takes years to build up equity in a home. But it all can be blown on a spending binge in a matter of days if you are not careful.

If you still want to pull equity out of your home and want to have less risk, the other option is a home equity loan. This is a fixed rate, fixed term second mortgage. You will have a fixed payment for up to 30 years. The interest rate may be higher than the HELOC at first, but it will still be a lot lower than consumer interest rates. A home equity loan can be a good fit if you want to have less risk and need to have a lump sum of cash right away.

The bottom line on second mortgages is they are probably the least expensive loan you can get for things that you need. A loan that is secured by your home will always have a lower interest rate than an unsecured loan. But it is easy for homeowners to abuse a second mortgage, so use it with caution. Also, if you have a higher rate on your first mortgage than current rates, you also can do a cash out refinance on your first mortgage.