Brenda Schmerl was eager to renovate her bathroom—and, after learning her upgrades would cost around $16,000, had assumed she would finance her project with a home equity line of credit, or HELOC.
Yet after shopping around for a HELOC, she was shocked to find this option had all but disappeared.
“The bank where I have my mortgage isn’t doing them; it says so right on the website,” recalls Schmerl, who lives in Brooklyn, NY. “I looked at some of the other bank sites, and it seemed like no one is doing them.”
Why is that? And, given few homeowners have a chunk of cash set aside to finance their renovations outright, what should they do?
Where have all the HELOCs gone
For decades, a home equity line of credit has been a common way for homeowners to finance a renovation. In a nutshell, a HELOC works as a second mortgage or lien on the home. Homeowners use their HELOC as a credit card of sorts, paying interest only on the money they withdraw for renovations.
Sheltering at home during the coronavirus pandemic has gotten many homeowners itching to renovate, spurring a high demand for HELOCs. So why has this financing option lately become harder to find?
According to real estate experts, the pandemic has lenders fearful of a repeat of the 2008 housing crash. Back then, many homeowners defaulted on their mortgages, prompting a wave of foreclosures and bankruptcies. Depending on other debts, there was often little or no money remaining for the issuer of the HELOC. The bank holding this second lien was often left holding the bag.
“At that time, many lenders were forced to take losses on the home equity lines of credit that were outstanding,” says Jeffrey Lloyd, principal at Mortgage Acuity based in Hackensack, NJ.
As a result, he continues, “lenders, especially banks, are wary of HELOCs because they’re less secure loans. The lien against one’s home is subordinate to the first mortgage.”
Another problem is that today’s low interest rates mean many lenders are inundated with requests to refinance, forcing HELOCs further down their list of priorities.
“Even though credit availability for HELOCs has loosened up and housing prices have soared, many lenders have a capacity issue,” says Greg McBride, chief financial analyst at Bankrate.com. “The boom in mortgage refinancing and availability of cash-out refinancing means some loan officers and processors previously assigned to home equity are now devoted to mortgage refinancing.”
In addition, HELOCs as a financial product are not as profitable, comparatively, for banks.
“HELOCs take the same amount of work to originate as a second mortgage, but there is no guarantee that someone will use the line so the lender can make money,” explains Khari Washington, founder and broker at 1st United Realty & Mortgage. “So the loan has high upfront costs with no proof of return.”
Will HELOCs ever return?
HELOCs have not completely disappeared; they are just harder to find. Schmerl continued shopping for a HELOC, and was eventually able to find two lenders willing to work with her.
“Borrowers with good credit and a healthy equity cushion are still in demand by lenders,” says McBride. “While some lenders have completely discontinued home equity loans and may not be offering home equity lines of credit right now, plenty of lenders still are. It pays to shop around.”
“It will open up when the perceived risk of foreclosures abates,” says Lloyd.
Yet exactly when foreclosure fears will lift is unknown, particularly since mortgage forbearance, which the U.S. government put into place during the pandemic—essentially freezing mortgage payments for unemployed homeowners—ended in June. Some experts believe we have yet to see the effects of that.
“The story is there could be a wave of defaults on the horizon,” Lloyd warns.
And while there are some good economic indicators, such as lower unemployment, there are also new forces at play. Supply chain problems are increasing the cost of building materials, resulting in fewer new homes and higher renovation costs.
Other ways to finance a renovation
This scarcity of HELOCs has forced many homeowners to consider other ways to finance their home improvement project—like a cash-out refinance, where you refinance your original mortgage but take out a portion of your equity in cash.
“If you haven’t already refinanced your mortgage and could profitably do so, a cash-out mortgage refinance will be the optimal way to tap into your equity,” says McBride. “With 30-year fixed rates around 3% and 15-year fixed rates in the low 2s, this is the lowest-cost way to access equity.”
Schmerl, for one, did consider refinancing.
“But my mortgage has an extremely low percentage rate that would be hard to beat,” she says. She briefly considered applying for a zero-interest credit card.
“I figured I could pay it off by dipping into my savings before the interest-free period expired,” she explains. “But I have good credit, I’m employed, and I have equity in the home, so I wanted to look around for a low-interest way to finance it.”
There are also other home improvement loans to consider that aren’t so well-known.
“For energy-efficient renovations, PACE loans finance repairs as well,” says Washington of the Property Accessed Clean Energy program.