Homeowners across the country are currently sitting on a significant amount of equity in their homes, with a total of $17 trillion in equity as of the end of the first quarter of 2024, according to CoreLogic. This figure represents a substantial increase in equity, with the average homeowner gaining $28,000 compared to the previous year. This surplus of equity presents homeowners with a valuable financial asset, but the question remains: when is the right time to tap into this equity?
Home equity is often seen as a valuable resource that should be preserved and protected, similar to a savings account. As Greg McBride, chief financial analyst at Bankrate, aptly puts it, “Home equity is not like bread; it won’t go stale if it just sits there.” However, there are certain circumstances where tapping into your home equity can be a strategic financial move, particularly when it comes to making major home improvements or repairs.
Benefits of Tapping into Home Equity
One of the main advantages of tapping into your home equity is that it can serve as a less expensive borrowing option compared to other forms of debt. According to a survey by Bankrate, 55% of polled homeowners view home improvements or repairs as a good reason to tap into their home equity. This sentiment is echoed by McBride, who emphasizes that using home equity is a more cost-effective option than resorting to personal loans or credit cards.
As of August 7, the average interest rate for a home equity loan stands at 8.59%, while the average HELOC (Home Equity Line of Credit) interest rate is slightly higher at 9.37%. In comparison, the average interest rate for a personal loan is 12.38%, and credit card interest rates are significantly higher at 24.92%. This disparity in interest rates highlights the potential savings that can be achieved by using home equity to finance major expenses.
While cash savings remain the most common way for homeowners to fund renovation projects, credit card usage for such endeavors has been on the rise. The 2024 U.S. Houzz & Home Study found that about 37% of homeowners paid for their repair projects with credit cards, marking an increase from 28% in 2022. Despite the convenience of using credit cards for immediate financing, tapping into home equity remains a more cost-effective option in the long run.
Risks of Tapping into Home Equity
Although tapping into home equity can offer financial benefits, it is not without risks. With the Federal Reserve implementing rate hikes, interest rates on home equity loans and HELOCs have also increased. This means that homeowners need to be mindful of the potential for higher borrowing costs when considering tapping into their equity.
Furthermore, using home equity to finance non-essential expenses, such as vacations or big-ticket items, is generally discouraged by financial experts. McBride cautions against financing vacations with home equity, stating that if you need to borrow money for a vacation, it may be a sign that the trip is beyond your financial means. Similarly, purchasing depreciating assets like cars or electronics with borrowed funds can lead to long-term financial strain, as you are essentially financing the decline in value of these items.
Investing in Your Home with Home Equity
Despite the risks involved, there are strategic ways to utilize home equity to enhance the value of your property. Jessica Lautz, deputy chief economist at the National Association of Realtors, emphasizes that investing in your home through renovation projects can not only preserve the property but also increase its overall value. This can translate to higher profits when you eventually decide to sell your home.
According to the latest Remodeling Impact Report by NAR, certain home improvement projects have a high percentage of cost recovery. For exterior projects, new roofing boasts a 100% cost recovery rate, while interior projects like refinishing hardwood floors and installing new wood flooring have cost recovery rates of 147% and 118%, respectively. These findings underscore the potential financial benefits of investing in your home through strategic renovation projects.
Lautz points out that hardwood floors, in particular, have universal appeal and can significantly enhance the aesthetic and resale value of a property. On the other hand, major projects like roof replacements are essential for maintaining the structural integrity of a home and are often prioritized by homebuyers. By strategically using home equity to fund these types of projects, homeowners can not only enjoy their living space but also increase the market value of their property.
In conclusion, tapping into your home equity requires careful consideration and a clear financial plan. While using home equity for essential expenses like home improvements can be a smart financial move, using it for non-essential purchases or vacations can lead to long-term financial strain. By weighing the benefits and risks of tapping into your home equity and aligning your financial goals with strategic investment opportunities, you can make the most of your home equity and maximize the value of your investment.