There's More to the Hot Housing Market than Buying and Selling
Home values - and prices - continue their upward trajectory. It's proving to be irresistible for many homeowners who are selling during this hot market, but there are other options to consider before sticking a "For Sale" sign in your yard. Let's talk about home equity line of credit (HELOC) and how you can put that to work for your home - and family. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
Today’s housing market has created quite a quandary for folks on both ends of the spectrum – buyers and sellers. Nationally, home prices appreciated in value 19.1% between January 2021 and January 2022, according to CoreLogic. That’s a whole lot of equity - about $9.9 trillion - that could be utilized for one reason or another even after retaining 20% equity in the home.
When you sell a house for an inflated price, you often have to turn around and buy - or rent - for an inflated price. But, there's a third choice - and it's an intriguing one: In today’s world of mind-boggling home value appreciation, you can capitalize on your equity through a home equity loan, a cash-out refinance, or a home equity line of credit (HELOC) and use the proceeds for something other than buying a new home.
A fourth choice, of course, is to do nothing and ride the valuation wave upward until it reaches a pinnacle (and it will reach a pinnacle).
Those decisions, of course, depend in large part on a family’s personal financial situation and, of course, risk tolerance. Let's analyze the options.
Selling & Buying (or Renting)
Due to inventory shortages of new and used homes, the equity you gain from the sale of your home is likely to become part of the cost of engaging in a bidding war for a new abode or for rent while awaiting market stabilization. And in some high-priced areas of the country, selling might trigger significant capital gains taxes on a big equity windfall even after considering the "primary residence exclusion," which is an IRS rule that allows homeowners meeting certain criteria to exclude up to $250,000 for single filers ($500,000 for married filing jointly) in capital gains tax from the profit made on their home sale.
Considering today’s competitive housing market, if you do not need to relocate or downsize, you should consider staying put and perhaps enjoying even more valuation increases. Selling a home comes with major costs and not-so-minor inconveniences. Seems to me, if there’s no good reason to cash out, then don’t do it.
Home Equity Line of Credit
A home equity line of credit (HELOC) is borrowed against the available equity in one’s home, collateralized by that home. It provides a revolving credit line to use for various reasons, including:
home renovations or improvements
investing in equities or an income-producing property
education or medical purposes
a vacation property
to acquire property on which to build a new home
consolidation of other, higher-interest rate debt (credit cards, for example)
In a limited inventory market, buying a lot on which to build a house presents several opportunities, including:
The homeowner can avoid renting by staying in his or her home during construction.
If valuations continue to rise, the family can take advantage of additional equity growth.
By building a home the family can tailor the home to their needs and avoid the bidding fiascos that often lead to costly mistakes during the buying process.
How A HELOC Works
Because a homeowner is borrowing against available equity and because the home is used as collateral, as the outstanding balance is repaid the amount of available credit is replenished. Specifically, throughout the draw period (typically 10 years), the homeowner can borrow against the replenished HELOC, as little or as much as is needed up to the credit limit established at closing. At the end of this draw period, a repayment period (typically 20 years) begins. In short, like a credit card, a HELOC is a revolving line of credit that the homeowner pays down, incurring interest only on the portion of the line used.
To qualify for a HELOC, you must have equity in your home. What's that? The (positive) difference in the home’s appraised value and your current mortgage balance.
A rule-of-thumb is that a homeowner can borrow up to 85% of the value of their home minus the remaining balance of a mortgage. Typically, there are no closing costs or application fees and no annual or usage fees. HELOC interest rates are often lower than other forms of credit due to a lender’s reduced risks. However, many HELOCs carry a variable rate that can change over time based on The Wall Street Journal prime rate. Not surprisingly, your credit score and employment history as well as monthly income and debt come into play when qualifying for a HELOC.
Word Of Caution
Keep in mind that when a home secured by a HELOC is sold, the loan must be paid in full. Don’t get caught owing more on the loan than the home is worth. And the housing market will cool down...there are signs that could happen soon.
On Monday, April 11, lumber futures fell to $870 per 1,000 board feet – a price hovering around levels experienced back in early December 2020. Also, note that because mortgage interest rates are rising (nearing 5%) and inflation is at historic levels (8.5%), demand for housing is softening (i.e., the current market is experiencing a noteworthy 40% decline in year-over-year mortgage applications). Higher rates make homes less affordable, lifting monthly mortgage payments. This cooling of the housing market could lead to a slowdown in new construction, contributing to a continued decline in lumber prices. Conversely, a reduced inventory of new housing might counter softening price trends. Crystal ball, anyone?
Do Your Due Diligence
If you decide to sell, whether to gain access to equity or not, first consider locating a replacement homes (or rental) before selling. Bidding wars are part of today’s landscape, leading to overpayment potential, or in the case of used homes, overlooked structural or mechanical problems due to lack of due diligence. If building a new home is a viable option, the use of equity to acquire a site for the new home might help obviate existing inventory problems. But building a new home has its own challenges (location, available utilities, construction loans, etc.).
And borrowing against home equity is not risk-free. Ensure that the reasons for home equity exposure are sound ones. For example, you may not want to fund a lengthy vacation to Eastern Europe with a HELOC.
And borrowing against home equity is not risk-free. Ensure that the reasons for home equity exposure are sound ones. For example, you may not want to fund a lengthy vacation to Eastern Europe with a HELOC. urself. S ince I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.