Take Out Equity, Take On Debt

Real estate is of vital importance for a majority of Americans. According to a study by the Federal Reserve from August of 2020, real estate makes up more than half of Americans’ net worth. Considering that the median home price is up 16.2% since then, it’s safe to assume that an even larger percentage of Americans’ wealth is tied up in their home.

All this means that Americans collectively have $9.1 trillion (yes, with a T) in home equity as of Q2 2021. That is a mind-boggling amount of wealth. Not surprisingly, many Americans have discovered strategies for tapping into that wealth without having to sell their home. Home equity loans, home equity lines of credit (HELOC), or cash-out refinances have been like toilet paper during COVID—everybody wants some.

There is no question that these tools to access the wealth trapped in your home can be immensely helpful to families in a number of ways. People can pay off high-interest credit card debt, make that home improvement they have always wanted, or maybe go to Tahiti. All of this can be done with record low interest rates, and, in some cases like home improvements, there may be tax advantages as well.

However, it’s critical to understand one thing: When you take out equity, you take on debt.

Accessing your equity is not free. No matter the vehicle you use, as a borrower, you become indebted to the lender. It’s important to understand that the cash that you take out of your home is not your money—it belongs to the bank. That money is secured by your home, and the bank is letting you borrow and pay interest as you go. All of these vehicles are liens against the property, meaning upon sale, the bank gets paid before you do.

There can also be some costs that the average consumer is not aware of, like closing costs, appraisal fees, and adjustable interest rates.

1. Closing costs: For vehicles like a HELOC, these can be as low as a couple hundred dollars. For refinances, it could easily be north of $10,000, depending on a number of factors.
2. Appraisal fees: In order to access your equity, the bank will need to determine an updated appraised value of your home. Depending on the area and size of the home, this can be several hundred dollars or more.
3. Adjustable interest rates: That 0.9% interest rate sure looked good when you signed on for your loan. But that rate can be adjusted after an introductory period, or if national interest rates increase over time.

This has not stopped many Americans from cashing in on the meteoric rise of residential real estate prices and continued nominal interest rates. 1.1 million cash-out refinances were originated between April and June for a grand total of $63 billion of equity withdrawn in 3 months[1]. That’s a lot.

Every last cent of that $63 billion has an interest rate attached to it. It is all debt that needs to be repaid to the lenders.

To be clear, utilizing home equity is not a bad thing, especially at such low interest rates. It can be a wonderful tool when used properly and for prudent reasons. Improving your home in a way that increases its resale value while potentially getting a tax deduction on interest paid may be a sound strategy. Paying down high-interest debt to reduce your monthly burden and overall cost of the loan can be a great idea for some. Covering the cost of a medical emergency at low interest can also be smart. Investing in a business, education, or some other asset can be a good idea as well.

In each of these situations, it is important to be aware there are risks associated with increasing debt or becoming over-leveraged. It is always wise to work with your financial and tax advisors to help determine the best strategy for your goals or situation. If home equity is your best source for the goal, you should then seek out the appropriate lending professional to help with the implementation of the strategy. Just remember, when you take out equity, you take on debt.

[1] Black Knight Mortgage Monitor Report for July 2021 is Now Available (blackknightinc.com)