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Spokane, Washington  Est. May 19, 1883

House rich, cash poor: Why a home-equity loan may not be a good idea

This home for sale is shown in Spokane Valley on April 13, 2019.  (Kathy Plonka/The Spokesman-Review )
By Michelle Singletary Washington Post

It’s hard not to see your home as an ATM.

U.S. homeowners with mortgages have watched their equity increase by about 32% year-over-year, representing an equity gain of $3.8 trillion, or an average increase of $63,600 per borrower, since the first quarter of 2021, according to CoreLogic, a real estate analytics company.

The increase in home-equity wealth is expected to spur a record amount of home-improvement spending, CoreLogic projects.

One Colorado reader called my 1-855-ASK-POST (1-855-275-7678) toll-free line asking for advice on using her home equity to remodel her home.

Background: The caller is single and 62. No children. She’s retired.

She owns her home outright, and it’s worth approximately $520,000.

She has about $350,000 in retirement funds spread across bank accounts, mutual funds, 401(k)s, 457s and IRAs. But this money has to last throughout her retirement years.

“My Social Security has not kicked in yet, although I have applied for it,” she said. “I’m living off my investments and credit cards.”

The repairs she wants to make are more cosmetic than necessary.

“The repairs would be nice to have, such as remodeling my bathroom and kitchen,” she said.

Her question: “Should I, given the rise in interest rates, take out either a mortgage or a home equity line of credit to finance repairs?”

Her debt situation: She has outstanding credit card debt of about $34,000 on three cards. She still has about $11,000 in student loan debt.

Her options: Homeowners have a few ways to access the equity in their homes – a cash-out refinance, home-equity loan or a home equity line of credit (HELOC).

With a cash-out refinance, you replace your current mortgage and borrow cash from your home equity.

If you own the home outright, you’ll get more cash out of the deal because there is no existing mortgage to pay off.

A home-equity loan, also known as a second mortgage, enables a homeowner to borrow money by tapping into the equity in their home.

The loan is disbursed in one lump sum and paid back in monthly installments.

A HELOC is secured by your home and gives you a revolving credit line similar to a credit card.

As you repay the balance, your available credit is replenished. HELOCs often have a variable interest rate. The interest rate tends to be lower than what lenders charge for a credit card or personal loan.

Given the caller’s situation, I wouldn’t recommend a HELOC. Here’s why:

To beat back inflation, the Federal Reserve expects to continue to raise interest rates.

If your loan has a variable rate, the interest rate will likely increase.

If you’re already struggling to pay your bills, getting a HELOC for home improvements that aren’t necessary isn’t financially prudent.

Alternatives to a HELOC: There are state and local programs that may assist with home repairs.

Contact your local or county government housing department to check if you are eligible for such a program.

I asked the caller if she had considered a reverse mortgage, which gives seniors a way to tap into the equity in their homes.

“I did think about a reverse mortgage, but wouldn’t I be obliged to stay in my home for the rest of my life?” she asked.

Unlike a traditional home loan, you don’t have to make monthly payments on a reverse mortgage.

The loan isn’t paid until the homeowner moves, sells or dies.

When the home is sold, any equity that remains after the loan is paid off is distributed to the person’s estate.

Typically, a reverse mortgage works best if you plan to stay in your home for a long time.

“I believe I could age in place at this house,” the Ask Post caller said. “My family has lived in this home for 52 years, and it is perfect for a senior citizen.”

Borrowers can take the reverse mortgage loan as a line of credit, a lump-sum payment, fixed monthly payments or a combination.

The loan size depends on the borrower’s age and other factors.

To qualify for a reverse mortgage, you must be 62 or older.

You have to have paid off your mortgage or paid down a considerable amount so that you have equity.

Your home must be your principal residence. Most important, borrowers must maintain the home and pay property taxes and homeowners insurance.

A reverse mortgage wouldn’t be a bad option.

She could use the loan to get rid of the credit card and student loan debt and make the repairs she wants.

But I suggested she come out of retirement and work full time or part time to save up the money for home improvements.

“I am considering a part-time job,” she said. “The city is looking for retirees who can work part time as lifeguards. The salary will not be great, but something is better than nothing.”

One thing she should keep in mind.

Since she hasn’t reached her full retirement age, Social Security will deduct $1 from her benefit payments for every $2 she earns above a certain annual limit.

For 2022, that limit is $19,560.

This is a case of being house rich and cash poor. I generally recommend you only cash in on your home equity when you have to make needed repairs.

By that, I mean your roof is leaking, or there’s an issue that jeopardizes the safety of your home.

“At this time, my gut instinct is to say I should delay as much as possible,” the caller said.

I agree.

If you have equity in your home, don’t let debt be your first choice to get at that cash.

Make it your last resort.