Last month, Dennis Shirshikov and his wife, Natalie, decided they needed to renovate the kitchen, siding and roof of their house in Greene, New York. Then they started crunching numbers on how to afford it.
“Our home was built in 1851, so there’s always something to update,” says Dennis Shirshikov, who works as a strategist at real estate investment company Awning.
Though they wanted to use the equity they’d built up in their home, a cash-out refinance was out of the question. They had locked in a 3.25% interest rate on their mortgage, and refi rates were already much higher. Plus, it would have extended the term of their mortgage.
Ultimately, the couple opted for a home equity line of credit, or HELOC.
“We didn’t want to get stuck holding the cash and paying interest if the work got delayed,” Dennis Shirshikov says. “The HELOC gave us the most flexibility.”
They had good reason to take advantage of their home’s increase in value. Thanks to market conditions, home equity gains are at record highs. In fact, homeowners gained a record-high aggregate of $18.4 trillion in equity during the first three months of 2022, according to TransUnion’s most recent Credit Industry Insights report. That’s about $233,000 per homeowner.
HELOCs in particular have surged in popularity, increasing by 41% year over year.
How a HELOC works
Home equity represents the value of how much you own outright in your property. You can calculate your equity by taking the fair market value of your house and deducting any liens, like mortgages or other types of credit that use your home as collateral, attached to the home.
A HELOC is a loan secured by your home. In order to qualify for a HELOC, the homeowner must generally have at least 15%-20% equity in their home, a credit score of at least 640 and a debt-to-income ratio of less than 43%. Once you’re approved, the “loan” actually works like a revolving credit account such as a credit card. You can use all or part of the money for any purpose or leave it as an emergency fund.
The big advantage of a HELOC over a home equity loan, for example, is that you only pay interest on the amount you actually use — not on the entire line of credit.
On the downside, the interest rate on a HELOC is typically adjustable. While the initial rate may be low, there is always the risk it could increase multiple times throughout the life of the loan. (You should learn more about the pros and cons of HELOCs and how to qualify before deciding if it’s the right choice for you.)
HELOCs got a bit of a “bad rap” in the aftermath of the Great Recession, says Michele Raneri, vice president of U.S. research and consulting at TransUnion. Homeowners who took out home equity loans and lines of credit on overvalued properties wound up underwater when the market crashed.
Since then, however, they’ve been making a comeback, especially now that current mortgage rates have increased by as much as 2 percentage points. Tapping into the equity gained over the past two years can be a more affordable option for accessing cash than refinancing, getting a personal loan or using credit cards.
“It’s actually a good tool when it’s considered for the right reasons,” says Raneri, adding that it “allows you to peel off a piece of your equity and only use what you need.”
What you can use a HELOC for
Your HELOC doesn’t have to go towards a home-related expense. You can use a line of credit to pay for a variety of expenses, including things like college tuition or to pay down higher-interest debt.
In a 2021 survey by Credit Karma, 41% of homeowners who took out a line of credit did so to make renovations, says Andy Dalton, vice president and general manager of mortgage at the personal finance company. The appeal has only increased this year: In April, HELOC activity was up 65%, the highest number of those lines of credit originated in the last 10 years.
But home improvements weren’t the only reason folks opted for HELOCs. In Credit Karma’s poll, 31% of respondents said they used a HELOC to pay for unexpected expenses. Another 27% obtained the line of credit to pay for necessities like groceries, utilities and other bills.
“This illustrates the ‘tale of two cities’ that persisted throughout the pandemic,” Dalton says, referring to how unevenly COVID-19 has impacted Americans’ lives. While some homeowners were able to make their homes more comfortable or better suited to their needs, he adds, others “were forced to use a HELOC as a lifeline.”
Now, as inflation is near 40-year highs and economists debate whether we’re in a recession (or headed into one), more homeowners may turn to HELOCs as a hedge against what could go wrong in the future.
That uncertainty over what the future holds is what motivated Trave Harmon, chief executive officer at Triton Technologies, to take out a line of credit on his Plainfield, Connecticut, house. Harmon has excellent credit and very little debt but decided to use part of his home equity as a safety measure.
“The economy is changing, and insurance companies do not pay you for having low income or no job,” Harmon says. “So I took out a HELOC now just in case something happens.”
Every Saturday, Money real estate editor Sam Sharf dives deep into the world of real estate, offering a fresh take on the latest housing news for homeowners, buyers and daydreamers alike.