(WECT) - With home values surging, owners aren't sitting on the equity in their homes, they're borrowing against it.
New home equity lines of credit (HELOCs) have risen sharply this year, despite changes to federal tax laws that were predicted to make them unattractive. Typically, homeowners pursue a HELOC to either renovate, build, buy another home or pay off debt.
A HELOC is a line of credit, similar to how you would use a credit card. The homeowner uses it to make purchases and pay for them later.
Unlike a credit card, it's backed by your home. A material asset.
If the value of your home goes up (as many are), you are building up equity and a HELOC allows you to borrow against that equity. Purchases can be made on that line of credit under a variable interest rate for just about anything the homeowner chooses.
The flexibility and inflated home values are what got many people into financial trouble right before the housing crash in 2007. While the rules and oversight are different today, the rate of new HELOC's and cash-out refinances are back at pre-crash levels.
Some consider this a red flag, while other's see it as savvy homeowner's taking advantage of the equity at their fingertips.
Cash-out refi's are different from HELOCs in that the homeowner pays off their existing mortgage and replaces it with a new loan. Under this larger loan, they are able to absorb the difference between the two and use it as cash for any type of purchase. Plus, it's tax-free.
The concern comes in if a homeowner decides to use the equity on their home like they would a credit card for daily expenses or worse- to fund the purchase of big-ticket toys like cars and boats.
If home values then turn downward, the homeowner has eroded that equity they built up. It's now been spent on expenses that were never based on money in the bank but on the inflated value of their home.
Many homeowners have used them wisely to say, put new roofs and new HVACs on a property they are choosing to stay in. Others in Northern States are using their equity to purchase homes in our area for cash as they plan for retirement.
All borrowers need to fully understand the benefits and risks of both HELOCs and cash-out refi's. You'll likely pay closing costs and fees again which may make borrowing at all unfavorable.
In all cases, it's best to work in-person with a local mortgage consultant who can understand your history and future goals.
Given the pros and cons of both equity, tapping approaches, sitting down with a person who knows your local market may offer big advantages over online lenders who you can't meet in-person.