As home prices start to decline, homeowners are watching their home equity levels shrink too. But does that mean now’s the right time to tap into that equity with a home equity loan or a home equity line of credit? The short answer is, it depends.
Home prices appreciated dramatically during the pandemic and homeowners were left sitting on record levels of tappable equity in their homes. In 2022, home equity loans and HELOCs became increasingly popular as mortgage rates surged and cash-out refinancing lost its appeal.
But now those home prices are starting to level off and even fall in some areas, leaving homeowners with less equity to tap into.
If you think you may need to borrow from your home equity in the coming months, it may be a good idea to think about doing so before home values fall further. Before committing to a home equity loan or HELOC, though, consider what you’re going to do with the funds as well as how you plan to pay back the loan. Experts recommend avoiding tapping into your home equity just because you can.
“It may not be a bad time to take out a home equity loan or HELOC if you’re concerned about prices going down in your area and you’re financially stable enough to carry the loan,” says Vikram Gupta, head of home equity lending at PNC Bank.
Here’s what you need to know about how home prices affect your home equity as well as when it makes sense to tap into it.
How falling home prices impact your tappable equity
Put simply, home equity is how much house you own. Each time you make a mortgage payment, you build a little bit more equity. But your home equity also comes from home value appreciation. During the pandemic homebuying boom, home appreciation grew rapidly. But home values have since inched lower.
The median US home sale price fell by 3.1% in the year to May to $418,317, according to real estate brokerage Redfin.
In the first quarter of 2023, US homeowners saw their tappable equity levels slide by nearly 1%, according to property data company CoreLogic. But the average homeowner still has roughly $178,000 in tappable equity, according to data (PDF) from mortgage analytics firm Black Knight.
If you’re sitting on piles of equity and watching home values start to fall, you may be wondering if it’s worth tapping into that equity before things go even further downhill. First things first: There’s no need to rush out and commit to a home equity loan or HELOC. Home prices, while falling a bit, remain persistently high thanks to supply shortages in the housing market.
Until mortgage rates drop substantially, and more sellers are willing to list their homes, inventory will continue to apply upward pressure on home prices. As a result, your home equity is unlikely to take any dramatic hits in the near future. However, if you’ve been considering tapping into that equity, now may be a good time to do so.
How do home equity loans and HELOCs work?
Home equity loans and HELOCs are secured loans, meaning you use the difference between what your home is worth and what you owe on your mortgage as collateral. They differ in how you receive your funds and the rate at which you repay the loan.
Similar to a credit card, a HELOC offers you a revolving line of credit that you can tap as needed. HELOCs are divided into a draw period and a repayment period. The draw period is the time during which you can tap into the credit line, and typically lasts between 10 and 15 years. Depending on your lender, you may only need to make interest-only payments during the draw period.
During the repayment period, which typically lasts 15 to 20 years, you’ll no longer be able to borrow money and must pay back the principal and interest on what you’ve drawn. HELOCs typically have variable interest rates, though, which means your monthly payment is subject to change as interest rates fluctuate.
A home equity loan, on the other hand, functions more like a personal loan. You receive all of the funds from your loan upfront and you’ll pay it back over a set period. Home equity loans usually have fixed interest rates, so your monthly payment will remain the same for the duration of your loan. You’ll have a few different loan terms to choose from, typically ranging from five to 30 years. How much you can borrow depends on the lender, but generally you can get a loan for up to 80% to 85% of your home’s value, minus your primary mortgage balance.
Home equity loans and HELOCs tend to offer more competitive interest rates than personal loans or credit cards. The caveat is that they come with a major risk: If you’re unable to make your monthly payments, you could lose your home.
How to use home equity financing
The most common uses of home equity loans and HELOCs are for home improvement projects or debt consolidation. Completing a home improvement project, such as adding solar panels or a new kitchen, will in turn increase your home’s value. Plus, when used specifically for home improvements, the interest on your home equity loan or HELOC is tax deductible.
But with a clear plan, there’s no shortage of ways to utilize home equity financing.
Home equity loans are ideal if you need a large lump sum of cash all at once and want a fixed interest rate and monthly payment.
A HELOC may be a better option if you want access to an ongoing line of credit and you’re comfortable with a variable interest rate and monthly payments. If you’re unsure of the exact amount of money you’ll need, a HELOC gives you some added flexibility.
“Given where we are in the interest rate cycle with very high rates, it may not be prudent to lock in today’s high rate,” Gupta says. “It may be better to opt for a HELOC’s variable rate because when rates start going down in about a year, you can actually enjoy that ride. People seem to forget that as rates go down, their variable payments go down too.”
When it makes sense to tap into your home equity
Home values tend to appreciate slowly over time, but the housing market also experiences periodic booms. During these times, home values can increase almost overnight like they did in 2020 and 2021. But that doesn’t mean it’s necessarily a good reason to rush out and tap your home’s equity. It might make sense to do so, however, if you know exactly what you’re going to do with the funds and how you plan to pay the loan back.
“If you’re financially stable and gainfully employed, and the only thing that’s changed is the outlook on your home price, it could make sense to borrow against your home for a few reasons,” Gupta says. “Whether you want to have that money in case things go south or you have a project coming up in a year or two from now, it’s not a bad idea to get that financing in place right now rather than waiting until the last minute and not being able to borrow as much because prices have declined.”
Rather than letting national headlines about home prices dictate your moves, take a look at what’s really going on in your local real estate market. What home prices are doing at the national level may not ring true for your area. Mountain West housing markets were at the forefront of home price growth in 2020 and 2021, but in recent months, have seen prices fall the most. In contrast, east coast and Midwest markets that didn’t see prices skyrocket in the same manner during the pandemic homebuying boom have more room to rise today.
“The markets that went up less aggressively are still chugging along and appreciating at normal rates,” Gupta says. “It’s the markets that shot up in the double digits that have the most to be worried about.”
When to be cautious
Taking on additional debt is a decision that should be approached carefully, especially with a recession potentially looming.
“If you’re financially distressed, [a home equity loan or HELOC] will give you a short-term boost, but you may have to pay the consequences down the line if you can’t make the payments when they’re due,” Gupta says.
If you’re looking to use a home equity loan or HELOC to consolidate debt, experts recommend you get to the root of the problem first: your spending habits. If you take out a loan to consolidate your debt without addressing the behaviors that got you there in the first place, you’re likely to end up right back in debt.
In addition, experts caution against betting your house on nonessential expenses. Using a home equity loan or HELOC to pay for a vacation, for example, isn’t worth the risk of losing your home if you’re unable to afford the payments down the line.
“The most important metric is whether you can make the payment,” Gupta says. “If you can, you’re fine. But if you have any concern about being able to do so, I would be really cautious about borrowing against your home.”
