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Home equity loans vs HELOCs: Both are seeing big growth. What that means.



Even as more Americans put off their home purchasing plans due to high interest rates and high home prices, a growing number of homeowners are tapping into their home equity to remodel their homes or finance other purchases.

The annual growth rate of homeowner equity continued to increase, up by 18% year-over-year in the third quarter of 2022, reaching an all-time high of $20 trillion, according to a study by TransUnion. That represented an increase of $600 billion from the second quarter.

Home equity line of credit or HELOCs were up 41% year-over-year in the third quarter of 2022, while home equity loan originations grew 47% year-over-year in 2022, representing the most home equity loan originations on record since 2010, according to the report.

“The main reasons why homeowners utilize the equity available to them is to consolidate debt, home improvement and big ticket purchases,” says Joe Mellman, senior vice president and mortgage business leader at TransUnion.

Mortgage originations continued their slowdown in the face of higher interest rates, with the most recent quarter of data, third quarter of 2022, showing a 56% decrease year-over-year in overall originations, down to 1.5 million from 3.4 million in the third quarter of 2021.

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Homeowners who once considered selling their house and moving up now don’t want to leave a 3% interest rate for nearly double the rates and are using their equity to put money back into home renovations or consolidating other high interest rate debt.

HELOC vs. a home equity loan?

Both HELOC and home equity loans allow you to borrow against the equity built up in your home.

While home equity loans provide you with a lump sum amount that you’ll pay back in fixed installments over a predetermined period, a HELOC is a revolving line of credit. During the draw period, you can borrow up to a certain credit limit set by the lender, which becomes available again once you pay back the borrowed amount.

A HELOC allows homeowners to borrow as much as 85% of the value of the home, and repay and redraw as needed.

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What is required to qualify for a HELOC?

Many mortgage lenders require minimum credit scores of above 650, says Michele Raneri, TransUnion’s vice president of Financial Services Research and Consulting.

Lenders also require that borrowers have around 20% equity in their home to qualify, she says.

Banks also usually don’t do less than $10,000 in home equity line of credit, she said.

Should you get a HELOC or home equity loan?

HELOCs and home equity loans are important right now because they are the right tool for the right time for consumers, says Ranieri.

While with cash-out refinance, you’re refinancing the entire house, given the higher interest rates, a home equity line or loan allows you to peel off the amount that you need from your equity, says Raneri.

“And while the interest rate may be higher than what your mortgage is, you’re only financing that portion at a higher amount,” she says.

What should people consider when they take a home equity loan?

Remember, you’re using your home as collateral, so you should know how you’re going to repay it and “make sure to shop around for the best rates,” says Ranieri.

“There’s a little bit of a stigma, I think, or a concern that people have from the great recession because there were a lot of home equity loan delinquencies,” says Ranieri.

But the stronger mortgage underwriting standards this time around should guard against that, she believes.

Are there good uses and bad uses of a home equity loan?

“It’s a great time to open up a home equity account, but just to make sure that they have a clear vision of what they want to use and money for,” says Jeff Taylor, founder and managing director at MphasisDigital Risk and board member at the Mortgage Bankers Association. “There are uses for HELOCs that make sense and those that could end up getting the borrower in worse shape.”

Among the best uses for HELOCs are projects that reinvest in the home and possibly boost the value, such as additions, renovations and major repairs.

Many borrowers also choose to use a HELOC as a debt consolidation tool. HELOC rates are adjustable according to market conditions but are typically lower than credit card rates, some auto loan rates, and student loan rates.

The lower the interest rate, the more money borrowers can free up each month to pay down the balance or use toward other financial goals.

The trouble begins when borrowers use their HELOCs too much like a credit card –to fund lifestyle expenditures and not reinvest back to the value of the asset.

“Where I give caution is for people to take home equity line and go on vacation or buy a new car, what have you.”

Is interest on HELOC tax deductible?

If you use funds from a home equity loan or a HELOC for home improvements, you can deduct interest on up to $750,000. In fact, the only way that interest on these loans is deductible is if you use them for home improvements, according to the Credit Union of South California.

Check with your tax planner on other tax implications and restrictions.

Swapna Venugopal Ramaswamy is a housing and economy correspondent for USA TODAY. You can follow her on Twitter @SwapnaVenugopal and sign up for our Daily Money newsletter here.

This article originally appeared on USA TODAY: HELOCs and Home equity loans are on the rise. What does that mean?

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