By Matt Lucido, Co-Founder and CEO – Yardsworth
Homeowners have long used home equity loans and lines of credit (“HELOCs”) to access their home equity quickly, but today’s high-interest-rate environment means that the math just doesn’t make sense for many any longer. So, what’s a homeowner to do who needs cash quickly? The good news is that there’s a new way to access home equity without resorting to debt.
Home equity loans explained
Home equity loans and HELOCs, which are types of “second mortgages,” enable homeowners to tap into a portion of the equity in their home (the difference between a home’s current market value and its loan balance) and turn it into cash without selling their home. In other words, wealth that once was out of reach turns into ready money that can be spent meeting urgent needs and achieving other priorities.
For example, some homeowners use these proceeds from home equity loans or HELOCs to finance renovations and improvements to their homes, increasing their value. Others pay off medical bills, tuition to educational institutions, or business startup expenses, among other Things.
Of course, accessing home equity via debt, whether a home equity loan or HELOC, involves paying interest — so home equity loans were particularly popular when interest rates were sitting at historic lows. Given today’s interest rate environment, however, where 30-year mortgage rates have more than doubled in the past two years, it’s a markedly different story. Go to https://www.accreditloan.com/ to understand the process of borrowing money from a lender. Homeowners are still sitting on near-record amounts of home equity, but how can they capitalize on that equity value without taking on significant monthly payments and interest expenses?
Historically low interest rates followed by a swift spike
Before the pandemic, the US enjoyed a period of low and typically declining interest rates. As seen in this chart from the St. Louis Fed, US interest rates generally declined from 13%+ in the 1980s to bottom out at effectively 0 from the 2008 financial crisis through 2022. As a reference point, 30-year mortgage rates bottomed out at approximately 2.7% during this time. Unfortunately, periods of low interest rates, easy money, and economic stimulus due to the pandemic resulted in rapid and historic inflationary pressure on prices.
When Fed interest rates hovered around zero, the cost of borrowing against home equity with a HELOC or home equity loan became very inexpensive — some viewed it as almost free. Whether a first mortgage or a HELOC, the price of borrowing against one’s house was extraordinarily low, and taking out a home equity loan was also extremely reasonable, so the Math made sense for a lot of people.
Then, in 2022, the Fed began hiking interest rates again to combat inflation, which had reached its highest level in 40 years. The Fed has two goals, managing inflation and employment, and its toolbelt is blunt and imprecise — they can pretty much only raise or lower interest rates or synthetically adjust them through quantitative easing or tightening. At a high level, the idea behind raising interest rates to combat inflation is that consumers and businesses will make fewer purchases when debt becomes more expensive, reducing demand. When demand goes down, so will the prices for those goods.
When the Fed started raising interest rates in 2022, it did so quickly, raising rates 11 times over the course of just 16 months. These increases drastically changed the calculus for homeowners who had previously considered using debt to tap home equity. If you want to get professional advice on real estate investing, you may get in touch with real estate professionals from sarabirealtygroup.co.ke.
How higher interest rates affect home equity loans
The Fed’s decision to turn up the dial on interest rates directly impacted loans, including mortgages and home equity loans. Borrowing money became less attractive, even untenable.
New home buyers who had been hoping to buy a home suddenly found themselves priced out of the market, in part because high interest rates made mortgages more expensive. The home equity segment was impacted to an even greater extent, as home equity loans and HELOCs are typically priced several points higher than first-lien mortgages. With every increase in interest rates, there was a corresponding fall in the attractiveness and affordability of home equity loans.
The Fed’s federal funds rate finally reached a high of 5.25 percent to 5.50 percent on July 26, 2023, and has stayed there ever since. This has translated into similarly high mortgage rates —the average fixed-rate mortgage rate is currently 7.23 percent, with home equity loans and HELOCs often topped 10%. Indeed, the Fed’s recent meeting on January 31, 2024, brought no immediate relief, despite the bond market salivating over potential pending interest rate declines.
Now, homeowners who need home equity financing have a tough decision to make. They’re sitting on record levels of home equity, but is it worth paying 10% interest just to effectively transfer money from one pocket to another?
As expected, US homeowners have drastically reduced their appetite for home equity lending. Financial services company Black Knight notes that “over the last 15 months, there’s been nearly $200 billion less equity withdrawn — and reinjected into the broader economy — than might otherwise have been, due in large part to elevated interest rates,” Andy Walden, Vice President of Market Research for the company’s Data and Analytics Division, stated.
Whether homeowners need an infusion of cash to pay medical bills or other unexpected expenses, get the training they need to advance their careers, or renovate their homes, a home equity loan may no longer be the answer. Practically speaking, many homeowners have had to sell their homes to raise money despite the logical and economic hurdles involved due to a lack of attractive financing.
Today’s high-interest-rate environment necessitates reevaluating financial strategies and exploring alternative options beyond traditional home equity financing. Fortunately, some states, such as California, recently passed legislation that has begun to offer novel solutions that can help solve homeowners’ liquidity needs without requiring high-interest borrowing.
A new way to unlock value from property
In September of 2021, Governor Newsom signed the California HOME Act, also known as SB 9, into law, and the legislation’s provisions went into effect in 2022. This bill allows homeowners to subdivide their lots and build new housing on the previously unused portion, offering the first up zoning opportunities to homeowners in many of these communities in the last 80-100 years.
Homeowners can now sell the unused portions of their yards so that someone else can develop them. This means they can suddenly turn a bare patch of land they weren’t using into a check for six figures, debt-free.
These payments aren’t loans, so interest rates don’t change the math. The homeowner is simply compensated for their land, which a developer then utilizes to build new housing. While they could choose to do it all themselves, in many cases, the original homeowner doesn’t even need to worry about handling the bureaucracy or paying any associated fees. All of this is taken care of by the developer, who also oversees the construction of the new housing and sells or rents out the new unit.
In short, California homeowners now have a viable alternative to home equity loans and HELOCs — they can convert their real-estate assets into cash that can increase their net worth instead of simply shifting dollars from equity to debt, from one pocket to another.
A new way to derive value from property
California is just the beginning, however. As the housing crisis is felt across states nationwide, other housing markets are beginning to follow California’s lead with the HOME Act to not only encourage the development of affordable new homes, but also to help homeowners derive previously inaccessible value from their properties. As a result, homeowners can stay in their homes even when financial headwinds blow, increase their net worth, and access home equity without debt. There’s never been a better time to be a homeowner in California.
— Matt Lucido is a social impact entrepreneur and investor. He is currently the Co-founder and CEO of Yardsworth, an online real estate marketplace for buying and selling backyard land. In 2014, he was recognized by the LA Business Journal as one of the “Twenty in their 20s.” He holds an MBA from the University of Southern California and a Bachelor’s Degree from the University of Virginia, where he lettered on the Virginia Baseball team, founded a non-profit to benefit children of cancer patients, and co-founded a restaurant. He has since held strategy and finance roles at the Honest Company and CapNet Financial. More recently, Matt was a Principal and Investor at Wavemaker Partners, an $800m AUM Venture Capital Firm. He is a 3x Founder with 1 exit. He is also a member of the Jonathan Club in Los Angeles.
