Home equity is a significant financial asset for many homeowners, offering a potential source of funds that can be tapped into when necessary. As of the first quarter of 2024, homeowners in the United States collectively hold an impressive $17 trillion in home equity, with an average increase of $28,000 per homeowner compared to the previous year. Despite this substantial amount, many homeowners choose not to access their equity unless absolutely necessary. As Greg McBride, chief financial analyst at Bankrate, puts it, "Home equity is not like bread. It won’t go stale if it remains untouched".
While home equity can be a valuable resource, it is crucial to understand when it makes sense to utilize it. Experts suggest that tapping into home equity is most appropriate for significant home renovations or repairs. According to a Bankrate survey, 55% of homeowners consider home improvements or repairs a valid reason for accessing their equity. This survey included 2,294 U.S. adults, with 1,133 being homeowners.
Cost-Effective Borrowing
One of the primary advantages of using home equity is its cost-effectiveness compared to other borrowing options. As of August 7, 2024, the average interest rate for home equity loans is 8.59%, and for home equity lines of credit (HELOC), it is 9.37%. In contrast, personal loans have an average interest rate of 12.38%, and credit card rates are significantly higher at 24.92%. McBride emphasizes that accessing home equity is "definitely a more cost-effective borrowing option compared to personal loans or credit cards".
Risks and Considerations
Despite its benefits, accessing home equity comes with risks. The Federal Reserve's recent rate hikes have increased borrowing costs, making it essential for homeowners to have a solid repayment strategy. Additionally, while cash savings remain the predominant method for financing renovation projects, the use of credit cards is on the rise. A Houzz & Home Study found that 37% of homeowners used credit cards to fund their repairs, up from 28% in 2022.
Enhancing Property Value Through Renovations
Investing in home renovations using home equity can enhance a property's value. According to Lautz, deputy economist at the National Association of Realtors, using home equity for improvements can be advantageous, as it helps maintain the property and potentially increases its market value. The Remodeling Report by the National Association of Realtors highlights that exterior renovations, such as new roofing, can recoup 100% of their cost, while interior improvements like refinishing hardwood floors can yield a 147% return.
Strategic Renovations
Certain renovations have broader appeal and can significantly impact a home's value. For instance, hardwood floors are highly desirable, and larger projects like roofing should be completed before moving in to ensure optimal condition. Lautz explains, "Hardwood floors tend to have broader appeal. For larger projects like roofing, many prefer to have that completed before moving in to ensure it’s in optimal condition".
Avoiding Pitfalls: Misuse of Home Equity
While home equity can be a valuable financial tool, it should not be used for non-essential expenses like vacations or significant purchases. More than 10% of millennial homeowners believe these are valid reasons to access their equity, but experts caution against this approach. McBride advises, "If you need to finance your vacation, you likely cannot afford it". Additionally, big-ticket items such as vehicles or electronics depreciate in value immediately after purchase, making them poor candidates for financing through home equity.
Home equity is a powerful financial asset that, when used wisely, can provide significant benefits to homeowners. It offers a cost-effective borrowing option for essential home improvements and repairs, potentially enhancing property value. However, it is crucial to approach home equity with caution, avoiding its use for non-essential expenses that do not contribute to long-term financial stability. By understanding when and how to tap into home equity, homeowners can make informed decisions that align with their financial goals.
