[Dongeul Dongeul] "Using Home Equity for Living Expenses"... US HELOC 'Boom'

US Household Funds Used for Mortgage Loans
House Prices Rise, Securing Extra Money via HELOC
Number of Uses Increased 34% YoY Last Year
Concerns Over Recovery Due to Subordinate Liens

Recently in the United States, more people are taking out loans secured by their homes without restrictions on the use of the funds, using the money for living expenses or as investment capital in the stock market. This is a scene unfamiliar to Koreans, whose home equity loans have usage restrictions.

In the U.S., home equity loans are divided into two types, allowing various forms of loans secured by homes. The U.S. home mortgage market mainly consists of primary mortgages, which are loans taken out to purchase homes, and secondary mortgages, which are loans taken out again using the home’s net equity (home value minus existing loans) as collateral. Typically, Americans take out a primary mortgage to buy a home and then add a secondary loan for household funds.

Because there is high demand to secure extra funds using homes as collateral, a vibrant secondary mortgage market, known as Home Equity Loans, exists in the U.S. Why do Americans actively use secondary mortgages secured by their homes rather than unsecured personal loans?

Lower Interest Rates than Primary Mortgages... Withdraw Cash up to the Limit When Needed

The reason secondary mortgages are so popular is that they allow borrowing large amounts at low interest rates. Currently, personal unsecured loan interest rates in the U.S. reach 10.99% annually for borrowers with excellent credit scores. For those with average credit scores around 600, the annual interest rate ranges from 13.50% to 15.50%. In contrast, secondary mortgages can be obtained at interest rates in the 8% range.

Specifically, interest rates vary slightly depending on the type of loan. Secondary mortgages mainly include HELOC (Home Equity Lines Of Credit) and Home Equity Loans. As of this month, the average annual interest rates for Home Equity Loans and HELOCs are 8.48% and 8.65%, respectively.

[Image source=Getty Images Bank]

Home Equity Loans provide a lump sum loan with a fixed interest rate. On the other hand, HELOCs are variable-rate loans that allow borrowers to withdraw cash as needed, using the accumulated home equity as collateral. Cash withdrawn through HELOCs can be used for any purpose without restrictions. During the initial 10 years, principal repayment is deferred, and only interest payments are required, allowing borrowers to withdraw money repeatedly within the credit limit. When the full amount is repaid, the credit limit increases again. It works similarly to a credit card.

Rising Home Prices Increase Asset Value... Means to Secure Tuition and Living Expenses

Americans actively use HELOCs to take advantage of their lower interest rates compared to unsecured loans when they need to remodel their homes or face unexpected expenses.

Moreover, after the COVID-19 pandemic, the rapid rise in U.S. home prices significantly increased borrowers’ net asset values, fueling the HELOC loan boom. As asset values increased, more people secured cash through HELOCs to use for living expenses or investments.

[Image source=EPA Yonhap News]

According to Bloomberg, the number of HELOC users in 2022 increased by 34% year-over-year to 141 cases, the highest since 2008. Although 2023 figures have not been released, TransUnion, a credit reporting agency, reported a steady increase in HELOC account openings during the third quarter.

The surge in home mortgage interest rates has also fueled the HELOC craze. Previously, Americans seeking extra funds preferred refinancing loans over secondary loans like Home Equity Loans or HELOCs. They would take out a larger loan than their original primary mortgage to pay off existing loans and pocket the difference. This refinancing strategy is called "Cash-Out Refinance." During low-interest periods, this strategy allowed borrowers to secure substantial cash.

However, recently, soaring U.S. mortgage rates have reduced the available funds from refinancing. The 30-year fixed mortgage rate reached 6.81% this month, the highest this year. In July last year, the rate was only 5.3%. Refinancing into a larger loan now means much higher interest payments. As a result, HELOCs, which allow borrowers to withdraw only the amount they need using their home as collateral, have become a more efficient cash acquisition strategy.

Bloomberg recently featured a case of a couple whose assets increased due to soaring home prices, enabling them to secure extra funds through a HELOC. Ross and Sarah, living in Texas, withdrew $230,000 through a HELOC after their home, purchased for $560,000 in 2018, rose to $1 million. They used the money to repair a rental property and pay their children's tuition.

Difficulty in Recovery if Home Prices Fall... Potential to Cause Financial Market Instability

However, some express concerns that the secondary mortgage boom could potentially cause instability in the financial market.

Secondary mortgages are subordinate liens, meaning repayment occurs only after senior liens are fully satisfied during a foreclosure sale. If home prices fall and the foreclosure sale price is less than the primary mortgage, banks may not recover their loan principal. During the COVID-19 pandemic, major U.S. banks such as Wells Fargo and JP Morgan suspended new HELOC issuance due to rising unemployment and housing market instability.

The concept of borrowing against a home without restrictions on the use of funds may seem unfamiliar to us. It remains to be seen how the HELOC craze will impact the U.S. financial market in the future.