Cash-strapped Americans are using their homes to pay off debt and keep up with the rising cost of living.
The use of home equity lines of credit — a type of revolving loan that has developed a problematic reputation for its role in the 2008 financial crisis — is increasing after hitting post-crisis lows two years ago. The products have long been a popular means of financing home renovation projects, but lately mortgage lenders say many of the applications appearing on their desks are for debt consolidation.
“It’s so much easier,” says Rochelle Adamson, a self-employed hairdresser, virtual assistant and content creator who consolidated more than $55,000 in debt on seven credit cards with a HELOC she took out on a rental property last year.
“You take it a little more seriously because it’s not like you can just pull out this card and go to the store,” she added. ‘It’s linked to your bank account. You must log in. It’s attached to your house.”
The resurgence of HELOCs comes at a contradictory time for many homeowners’ finances: After several years of high inflation, many have more debt than ever. But they’re also at near-record levels of home equity: an average of $315,000, according to data provider CoreLogic.
Read more: What is a HELOC and how does a home equity line of credit work?
All told, households had about $35 trillion in equity in their homes at the end of June, Federal Reserve data show.
But as consumers’ home prices rose, so did their consumer debt. According to data from the New York Fed, credit card debt nationwide was $1.14 trillion at the end of June, up 5.8% from a year earlier. Auto loan debt has also risen, totaling $1.63 trillion.
“People are really struggling,” said Sarah Rose, senior home equity manager at Affinity Federal Credit Union. “Credit cards, personal loans – the rates for those are just astronomical. Consolidating those debts into a lower interest rate over 30 years is a winner for many people.”
The argument for using a HELOC to consolidate debt is relatively simple. HELOCs can have fixed or variable interest rates, usually the prime rate plus an additional amount known as a spread. The link to prime makes them one of the few types of loans where the interest rate adjusts almost immediately after the Fed changes the benchmark rate.
Rates vary depending on factors such as a customer’s creditworthiness, but have recently averaged around 9%, according to Bankrate. While that’s higher than the typical first mortgage rate, the math can be appealing for those carrying a balance on their credit card. As of May, the average card interest rate was more than 21%.
Read more: HELOC vs. Mortgage Loan: Which is Better When Interest Rates Are High?
Like credit cards, HELOCs are a form of revolving credit, meaning customers can tap the full amount they were approved for, but don’t have to, and regain access to the money after they’ve been paid off.
Customers typically have a fixed period in which they can use their HELOC – usually five to 10 years – and in some cases only pay interest on the balance during that time. After the draw period expires, customers have a fixed repayment period of up to 20 years.
To Adamson, who lives in Honolulu, Hawaii, with her husband and daughter, the math made sense. Before she took out the HELOC, she felt like her monthly credit card payments of as much as $3,200 weren’t making a dent in her overall debt load. The interest rates on her cards ranged from 18% to 22%, while her HELOC ranged from 10% to 11.5%.
“Interest can really play a big role in how much you can pay off, and how quickly,” she said.
Last year she paid off about $20,000 in HELOC debt, and after halting more aggressive payouts to rebuild a depleted emergency fund and withdrawing extra money to cover other expenses, she now pays about $1,000 a month in her balance.
There are reasons to be cautious about using a HELOC to pay off other debt. Ultimately, HELOCs are secured by one’s home, meaning that in a worst-case scenario, a lender could foreclose on the property if a borrower is delinquent.
And in some cases, customers may be approved for a larger credit limit than necessary to consolidate their debts, making it important to keep overall spending under control.
Gerika Espinosa, a financial planner at DMBA in Salt Lake City, Utah, says she only recommends using HELOCs as a debt consolidation tool if she is confident a client can live within means and won’t be tempted to spend more of the possibilities. credit limit than they need.
“HELOCs are like fire,” Espinosa said. “They can really help someone move forward if they are contained and managed properly. They can also get out of hand and be detrimental to someone’s financial situation.”
Although HELOC usage is growing, it is still a fraction of what it was during the financial crisis. Lenders extended more than $700 billion in credit lines in early 2009, but now have about $379 billion on their books. Many banks left the market or offered credit lines only sporadically when interest rates were low.
Achieve, a non-bank lender, began offering fixed-rate HELOCs focused on debt consolidation in 2019, a time when home prices were rising but few banks were active in the space. Kyle Enright, the company’s president of lending, said more conservative lending terms have allowed customers to use the lines responsibly.
“None of our borrowers have lost their homes,” Enright said. “Very, very few borrowers who took out HELOCs in the last five to six years have lost their homes. As long as the lender has reasonable underwriting standards, there is not much risk to the consumer.”
Claire Boston is a senior reporter for Yahoo Finance covering housing, mortgages and home insurance.
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