Leveraging Home Equity to Battle Rising Debts: The Resurgence of HELOCs

By Claire Boston

In recent financial news, cash-strapped Americans are turning to an often-overlooked financial tool—Home Equity Lines of Credit (HELOCs)—to tame soaring debts and combat the relentless rise in living costs. This trend marks a significant shift, as HELOCs are making a comeback after hitting post-crisis lows just two years ago.

A New Age for HELOCs

HELOCs, once infamous for their role in the 2008 financial meltdown, have evolved into a lifeline for debt-ridden homeowners. Traditionally favored for home improvements, these loans are now being used primarily for debt consolidation. Mortgage lenders report a surge in applications specifically aimed at consolidating high-interest credit card debts.

Rochelle Adamson, a self-employed hairdresser and content creator, is a testament to the trend. Consolidating $55,000 of debt across seven credit cards, Rochelle describes the transition to a HELOC model:

"You’re taking it a little more seriously because it’s not like you can just pull this card out and go to the store."

The Financial Landscape

The backdrop to this trend is a contradictory financial landscape. Inflation has increased consumer debt levels, with homeowners sitting on near-record home equity—averaging $315,000 per household, according to CoreLogic data. Federal Reserve statistics highlight a colossal $35 trillion of equity locked in American homes.

Yet, this equity boom is accompanied by soaring consumer debts. Credit card debt alone hit $1.14 trillion by June, marking a 5.8% increase from the previous year. Additionally, auto loan debt has climbed to $1.63 trillion.

Sarah Rose, a senior home equity manager, points out the stark contrast between the astronomical rates on credit cards and personal loans and the more manageable terms of HELOCs:

“Consolidating that debt into a lower rate over 30 years is a winner for a lot of people.”

Understanding HELOCs

HELOCs and their appeal rest on their financial structure. These loans can have fixed or floating rates, typically linked to the prime rate plus a spread. Currently averaging at around 9%, HELOC rates offer a stark contrast to the over 21% interest rates plaguing typical credit cards.

What makes HELOCs particularly attractive is their revolving nature, akin to credit cards. This means homeowners can draw, repay, and redraw within the set limit during the draw period, which typically lasts 5 to 10 years. After this period, they enter a repayment phase that can extend up to 20 years.

The Math in Action

Rochelle Adamson’s experience underscores the practical benefits. Pre-HELOC, Rochelle’s $3,200 monthly credit card payments barely dented her debt due to high-interest rates ranging from 18% to 22%. Post-HELOC, her payments are more manageable, with a range of 10% to 11.5%.

"Interest can really play a big part in how much you can pay off, and how quickly," Adamson explains.

She’s now paying about $1,000 monthly towards her HELOC balance, having first used the funds to clear $20,000 of debt and then pausing aggressive paydowns to rebuild her emergency fund.

Risks and Precautions

However, it’s crucial to tread carefully with HELOCs. Since they are secured against homes, a failure to repay can result in losing the property. Moreover, the temptation to borrow more than needed is a real risk.

Gerika Espinosa, a financial planner, cautions:

“HELOCs are like fire. They can help one progress well if contained and managed well. They can also get out of control and be a detriment to one's financial situation.”

A Prudently Managed Resurgence

Despite the potential risks, HELOCs are being extended more conservatively today than during the pre-crisis era. Even non-bank lenders like Achieve, which re-entered the market in 2019, emphasize responsible lending.

As Kyle Enright, president of lending at Achieve, asserts:

“Very few borrowers have lost their home. As long as the lender is employing reasonable underwriting standards, there is not a lot of risk to the consumer.”

Conclusion

With HELOCs emerging as a strategic tool to manage and consolidate debt, it's essential for homeowners to understand both their benefits and risks. By leveraging this financial instrument wisely, consumers can navigate their debt struggles more effectively.

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Claire Boston is a senior reporter for Yahoo Finance specializing in housing, mortgages, and home insurance.