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Home equity borrowing is on the rise, again

U.S. News & World Report - Money logo U.S. News & World Report - Money 5/12/2017 Joel Cone

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Prior to the Great Recession, interest rates were low, lenders were underwriting loans like crazy with virtually no pre-qualification, and home values were skyrocketing to the point that homeowners thought the good times would never end.

So borrowers tapped into this newfound wealth in their home equity and treated it like a bank ATM – purchasing expensive cars, taking lavish vacations, paying for their children's college educations, updating their homes and buying other things through the use of home equity lines of credit.

That is, until the housing market bottomed out in 2008 and everything changed.

"The way HELOCs were issued and used during the early-to-mid-2000s is a case study in how to do almost everything wrong," says Rick Sharga, executive vice president at online real estate marketplace Ten-X. "Unqualified borrowers were given home equity lines on egregiously overvalued properties, and often spent those funds unwisely. When the market turned, property values fell, and HELOC rates reset, many of these homeowners found themselves in a bad financial position, often resulting in a foreclosure."

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Basically, a HELOC is a line of credit using a home's equity as collateral. Once approved, the homeowner has a checkbook from which to draw down the line of credit to pay for various purchases, paying it back like a credit card but at a lower variable rate. Plus, unlike a cash-out refinance loan, the borrowers use only the amount they need, rather than locking into a higher loan amount, and are not resetting the interest rate on their primary mortgage.

"For responsible real estate investors, tapping into the equity in a primary residence in order to purchase properties they can rent out or fix-and-flip can be a great strategy," Sharga says. "And lenders are being far more conservative about property values – and about the creditworthiness of the borrower – than they were back in 2006."

Now, more than a decade later, home equity loans are rebounding in many parts of the country, and homeowners are generally feeling better about possibly drawing on that regained equity once again with HELOCs. Still, the fact that the level of HELOC activity is nowhere near the peak level reached in 2006 is evidence that lenders are maintaining much tighter underwriting standards these days.

"What we learned from 2006 is that it doesn't last forever. We're eventually going to see some kind of a drop," says Matthew Watercutter, broker and senior vice president at the Dayton, Ohio, office of HER Realtors. "This time HELOCs are being used on a more responsible basis. Investment properties and things that give them a better return. It's a reality check."

The number of HELOC originations has rebounded since 2011, due in large part to continued low interest rates, appreciating home prices, extreme shortages of housing inventory for sale, lack of new home construction and continued tight lending practices, all of which are keeping potential first-time and move-up homebuyers sitting on the fence instead of entering the market.

According to the most recent data provided by Attom Data Solutions based in Irvine, California, the number of HELOC originations nationwide fell from 3,304,427 in 2006 – when the company first began tracking the data – to 646,109 in 2011. Beginning in 2012 (when there were 655,889 HELOC originations) the trend reversed itself and has continued on an upward path since then to 1,219,333 reported last year.

For all of 2016, the number of HELOC originations increased 4.2 percent from the previous year, and was up 190 percent from the low point in 2011. The average HELOC amount has increased steadily from $154,782 in 2006 to $190,256 in 2016. So far in 2017 the average HELOC amount is $202,121.

"This is evidence that we're not seeing people use their homes as ATM machines to the extent they were 10 years ago," says Daren Blomquist, senior vice president at Attom Data Solutions. "Lenders, although they may be marketing aggressively, are still underwriting pretty conservatively."

More equity-rich homeowners means more HELOCs

What seems to account for this renewed interest in HELOCs? Blomquist says that more equity-rich homeowners (those who have more than 50 percent equity in their home), and fewer homeowners whose home mortgages are underwater is a major driver of the rising number of HELOCs.

"Since home prices bottomed out nationwide in the first quarter of 2012, the number of seriously underwater U.S. homeowners has decreased by about 7.1 million, an average decrease of about 1.4 million each year. Meanwhile, the number of equity-rich homeowners has increased by nearly 4.8 million over the past three years, a rate of about 1.6 million each year.

"Despite this upward trend over the past five years, the massive loss of equity during the housing crisis forced many homeowners to stay in their homes longer before selling, effectively disrupting the historical domino effect of move-up buyers that feeds both demand for new homes and supply for first-time homebuyers. Between 2000 and 2008, our data shows the average homeownership tenure nationwide was 4.26 years, but the average tenure has been trending steadily since 2009, reaching a new record high of 7.88 years for homeowners who sold in 2016."

Back in 2013, Attom reports that the number of equity-rich homeowners nationwide numbered 9 million. By year-end 2016 the number of equity rich homeowners numbered 13.9 million – a 54 percent increase in three years.

"It all ties in to people who regain their equity not selling as quickly as they did in the past," Blomquist says. "My theory here is at first they were forced to stay longer because lost equity in their homes kept them from being able to sell, but we are not seeing regained equity result in more of these borrowers buying new homes in part because there isn't a lot of inventory to choose from to buy a 'move-up' home."

Recently released homeownership tenure data from Attom shows that people are remaining in their homes about twice as long as they did before the Great Recession. That longer homeownership tenure is translating into greater equity build up and the rise in HELOCs.

"I do think that one of the trends this ties into is keeping the primary home and leveraging equity in that property to buy rental properties as well," Blomquist says. "It's a trend we're seeing in a number of markets – particularly in high-priced markets like the Bay Area."

Home improvement

As of the fourth quarter of 2016, in the Seattle-Tacoma-Bellevue metroplex, 32.5 percent of homeowners were equity rich, a 5.6 percent increase from the same quarter the year before. At the same time, homeowners who sold their homes in 2016 stayed in those homes for 9.67 years before selling, a 2.5 percent increase in ownership tenure from the year before, and a 55.5 percent increase from 2008.

Likewise, the number of HELOC originations – which peaked at nearly 26,000 back in the first quarter of 2006 – were down to almost 7,400 for the fourth quarter of 2016, a 72 percent decrease, but still a 6 percent year-over-year increase from the same quarter in 2015.

"The trends have been heading up for the past couple of years," says Matthew Gardner, chief economist at Windermere Real Estate based in Seattle. "It's not just limited to Seattle. I represent 6,500 brokers, and given the extraordinary lack of homes for sale, they can't buy somewhere else, so what they began to do is take the money out and start improving their existing residence."

As Gardner sees it, the trend to focus on home improvement in the present market makes sense since every market is "essentially crying for inventory," with existing homes for sale at the lowest point he's seen in 20 years.

"There used to be four to five months of inventory. Right now we're talking four to five weeks of inventory," he says.

On a year-over-year basis, in 2016 HELOC originations were up for all three metro areas serviced by HER Realtors; 17 percent in the Cincinnati metro area, 22 percent in the Columbus metro area and up 23 percent in the Dayton metro area.

The number of equity-rich homeowners also increased in all three metro areas on a year-over-year basis, as did the homeownership tenure.

"The market being the way it is, and lenders being a little more willing, we're seeing more HELOCs being used. Most of them being put back into the home for updates. Remodeling with new kitchens and bathrooms," Watercutter says. "Some are still being used for educational purposes. I have seen people using the money to buy an investment property. Maybe using it to help their kids get a house."

See: 8 Strategies for Investing in Real Estate

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