HELOCs now a riskier proposition for investors
High interest rates and economic uncertainty have made home equity lines of credit costlier and more precarious.
Key points:
- Valued at more than $28 trillion, U.S. homeowner equity remains near record highs.
- But tapping into that equity to use for additional property purchases could be risky.
- Lenders have been tightening their loan standards, a new Fed report indicates, including on HELOCs.
The near-record level of equity U.S. homeowners currently have in their properties — roughly $28.7 trillion, according to the Fed — may be a tempting source of funds for consumers who are feeling squeezed by the ever-increasing cost of goods and rising credit card debt.
But home equity lines of credit are a much riskier proposition today than they were just a year or two ago, thanks in large part to the steep increase in borrowing costs.
Just as low mortgage rates helped fuel the pandemic-era real estate investing boom, so too did home equity lines of credit, which investors would tap to fund additional fix-and-flips. But long gone are the days of low HELOC interest rates, which can now run upward of 10%.
Even so, there appears to be a surge of interest in HELOCs, based on Google search trends — which may be no coincidence considering that consumer credit card debt also hit a new record high in July, approaching $1 trillion.
'A very risky market' for investors
While HELOCs can play a crucial role in consolidating debt, they are a "calculated risk," Rick Sharga, Founder & CEO of CJ Patrick Company, a real estate market research consultancy, told Real Estate News. This is especially true for investors who used cheap money from cash-out refinances and new HELOCs during the pandemic to fund additional property purchases.
"This is a very risky market for an inexperienced investor to get into, particularly by tapping into the equity in the home where they live," Sharga explained. "You're taking a risk on the property you're buying, but if it goes south, you're also potentially risking your current home."
And the idea of taking out a new mortgage or HELOC today with the hope of refinancing once rates go down should not play into the math for prospective borrowers, Sharga said.
"I wouldn't advise somebody to 'marry the house and date the rate' if they're going to be overextending to get into the house today," he explained. "You should look at rates going down in a couple of years as a surprise bonus."
Lenders are tightening their standards
While big banks and private equity firms were scrambling to invest their cash into assets during the pandemic, the picture looks much different today, Sharga said, noting that lenders have tightened credit standards in recent months.
"Most private lenders are very reluctant to work with a new investor in today's market because of the risk," he said. "If they can get a loan, it's probably going to be at the high end of the interest rate range — they're not going to be looking at a Fannie or Freddie loan at 7%."
Recent Fed research backs this up. According to the latest Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), lenders have been pulling back from all residential real estate loan types, including HELOCs, and indicated they plan to keep tightening their standards through the rest of the year, particularly as property values fluctuate and liquidity dries up.
"The most cited reasons for expecting to tighten lending standards were a less favorable or more uncertain economic outlook, an expected deterioration in collateral values, and an expected deterioration in credit quality," the report indicated.