According to the Federal Reserve, U.S. homeowners have $29.5 trillion of real estate equity as of the third quarter of 2022. By any measure, this is a lot of money.
Historically, savvy homeowners have deployed the equity in their homes to strengthen their economic well-being and build wealth. However, putting home equity to work is an advantage increasingly inaccessible to a growing number of homeowners.
While “location, location, location” is the mantra in determining a home’s value, it’s a numbers game when it comes to leveraging that value. The impact of low credit scores, elevated levels of debt and rising mortgage rates has limited the reach of this dynamic driver of wealth.
Expanding mechanisms to leverage home equity is key to strengthening our communities and ensuring more equitable outcomes. Financial advisors serving clients with a sizable portion of their wealth held in a primary residence should take a closer look at the options available to homeowners to help build a sustainable financial plan.
Here are challenges advisors should consider when recommending these solutions to clients:
Reverse Mortgage
For aging homeowners near or at retirement age, a reverse mortgage might be a feasible option if they live in their homes and are at least 62 years old.
There are three types of this product so there is some flexibility. All are heavily regulated products and will require homeowners to complete financial counseling to determine if it is the right option for their financial situation.
For clients who have no debt other than an existing mortgage — proceeds from a reverse mortgage can only be used to pay the mortgage — this could be an option if there are no family members interested in inheriting the property. Because there is no payment schedule, cash proceeds — distributed as a lump sum, line of credit or monthly payment — can be repaid at any time, providing flexibility in managing cash flow and expenses.
However, the amount does accrue interest, so the balance increases over time – unlike a traditional mortgage that decreases with each payment.
Cash Out Refinance
The cash-out refinance option is ideal when home values are rising, and interest rates are falling. With the inverse occurring, it is not a feasible option for many homeowners today especially those looking to lower debt payments.
However, homeowners who insist on pursuing this option should understand:
The home’s existing value must be worth more than the mortgage amount.
This is considered a new loan, so mortgage payments restart from zero.
Closing costs are typically part of the cash-out finance options.
In addition, the homeowner must meet qualifying criteria of having a credit score and debt-to-income ratio that is acceptable to the lender in addition to at least 20% in home equity.
Frankly, this isn’t a great option for most homeowners today.
Home Equity Line of Credit and Home Equity Loans
The current national average for a 30-year-fixed mortgage is 6.37% and expected to rise as the Federal Reserve has signaled it will continue to bump rates higher to combat inflation. This makes home equity lines of credit (HELOC) and home equity loans a challenging proposition.
While HELOC proceeds can be used for anything, they are a revolving credit line and subject to rising interest rates. This could be adding new debt for a client trying to pay down or consolidate loans.
Home equity loans are fixed-rate debt instruments, so there is less risk of a ballooning payment. However, with interest rates climbing higher, homeowners should act quickly if this is the path they’d like to take.
Home Equity Agreements (HEAs)
A relative newcomer to the market, home equity agreements (HEAs) — also known as home equity investments (HEIs) — are not loans. There is no repayment term or interest charge. Instead, they allow an organization or individual to invest in a portion of the home’s existing equity. The investor provides a cash payment in a lump sum or scheduled disbursement.
This option may be feasible for clients who have poor credit or are struggling with mortgage payments because there are no restrictions on how the HEA payment is used. The funds could be used to raise credit scores by repaying outstanding debt and allowing the homeowner to refinance the current mortgage to one with a lower interest rate.
HEAs do have a termination date — usually 10 to 30 years — where the homeowner must buy out the investor’s stake or consider selling the home.
While all these options are available, they are not all within our neighbors’ reach. Home ownership remains the central tenet of the American Dream and a tangible representation of success. It can also be a springboard to ongoing wealth accumulation.
Companies and platforms dedicated to closing the wealth gap by offering accessible home equity access solutions, along with the technologies, expertise and support to increase the financial wherewithal of their clients can serve as the rising tide that lifts all boats.
Ashley Bete is CEO and Chief Investment Officer of Leap Analytic (https://www.leaphei.com/), a fintech real estate investment firm that seeks to transform the home finance marketplace and empower historically underserved communities to help close the wealth gap.
