Borrowing, Home Equity Loans & Line Of Credit

The Pool Is Shrinking

A home equity loan or line of credit (HELOC) can be a useful financial management tool – but only if you have the available equity to take advantage of it. Do you know how much you could borrow against your home if you had to?

Black Knight’s October 2018 Mortgage Monitor reports America’s total mortgage equity is at $9.8 trillion, with $5.9 trillion of that “tappable” – available for homeowners to use as borrowing collateral.

While $5.9 trillion is a large pool, it’s $140 billion less than it was in the previous quarter – the first quarterly decline since the housing crisis. Tappable equity fell in 60% of the 100 largest housing markets and twelve of the top fifteen. The average homeowner with tappable equity had $136,000 available for borrowing, a decrease of $2,300 from last quarter.

Is your tappable equity falling along with the average, or rising, as it should with your payments? The answer lies in your local housing market.

Where Did It Go?

People sometimes think of home equity as the percentage of their home that they own, which is misleading. Your home equity is 100% less the remaining loan balance compared to the value of your home. At the moment you buy your home, those two things are equal.

If you paid 20% down on your $200,000 home, you have $40,000 of equity in that home and owe $160,000. Your loan-to-value (LTV) ratio, or the amount of your loan balance compared to your home’s value, is 80% ($160,000 divided by $200,000).

Tappable equity, as defined by Black Knight, is the amount of money you can borrow before hitting a combined LTV of 80%. Currently, you’re already at 80% LTV and have zero tappable equity.

Now let’s assume you’ve paid off $100,000 of your $200,000 loan and the home is still worth $200,000. Your remaining LTV is 50%. Since 80% of $200,000 is $160,000, you could stay below a combined 80% LTV by taking out just under $60,000. That’s your tappable equity.

What if the market crashed and your home is now only worth $150,000? Your current LTV is 67% ($100,000 divided by $150,000). Since 80% of $150,000 is $120,000, and you still owe $100,000, your tappable equity has dropped to $20,000.

In short, home price swings have a huge effect on your tappable equity, independent of what you’ve paid against your loan.

Black Knight’s results illustrate this principle through the decline in home values in high-priced urban markets. Price declines in high-dollar, equity-rich markets lead to disproportionate drops in average tappable equity. California accounted for almost 75% of the decline, with more than half incorporated in three cities – San Jose, San Francisco, and Los Angeles.

If your local market is staying relatively stable, the decrease in tappable equity doesn’t affect you as much. Your equity is more dependent on how much of your loan principal you’ve paid down.

Home improvements can affect your available equity in both directions. Equity will eventually increase as you add to your home’s baseline value, but tappable equity will drop in the short term if you took out a home equity loan to finance the improvement.

Should you tap into home equity at all? If you do, you’ll increase the overall amount of debt secured by your home. Consider if there’s a better way to finance your current needs – especially if you aren’t completely sure you can make the payments, or your housing market is prone to huge price swings.

Equity Goes in As Well As Out

You can increase equity significantly by making an extra payment against the principal, if your loan terms allow it. A high percentage of early mortgage payments are devoted to interest. By making an extra payment dedicated to the principal, you can raise equity for future loan needs while significantly reducing overall interest payments.

Should you increase tappable equity with extra payments? The main motivator should be interest savings. If you’re carrying credit card balances with high-interest rates, you probably should pay that down first – especially if you’ve been making home payments for years and the savings from an extra principal payment are diminished. Use an online calculator to determine economic trade-offs or consult with a financial professional if you can’t decide.

Extra payments against principal don’t protect you against home value changes. If you make extra payments and the market falls, the drop in your home’s value could swamp the value of your extra payment.

The Takeaway

You can’t affect changes in your available home equity from housing market fluctuations and external economic changes. You control your tappable home equity in two primary ways – through payments that increase it and loans that reduce it.

Changing your available home equity with anything other than regular payments carries risk. Using any portion of your home as collateral opens up the risk of losing your home if you default. However, with collateral you usually receive lower interest rates and fewer restrictions.

Treat home equity borrowing as a way to increase return on some investment. Keep your credit score high to lower your interest rate offers and increase your return even further. Check your credit score and your credit report for any errors or issues that may affect your pending loan. You can check your credit score and read your credit report for free within minutes by joining MoneyTips. Do you have some cleanup work to do before you borrow?

MoneyTips is happy to help you get free mortgage and refinance quotes from top lenders.

Photo ©iStockphoto.com/LIgorko

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