With the jobless rate spiking into the double digits, more Americans may look to unlock the wealth tied up in their homes to get through the crisis. Problem is, banks won't give up the key.
Lenders are increasingly turning away homeowners looking for equity lines of credit or a cash-out refinance, spooked by the surge in unemployment and the jump in requests by borrowers to skip mortgage payments.
After years of rising home prices and the longest stretch of economic growth in history, Americans have amassed $18.7 trillion in real estate equity, a cash cow that’s now untouchable, forcing some of them to seek other, less favorable alternatives.
"This is a good lesson that home equity is a very illiquid asset,” said Matt Hylland, a partner at Arnold and Mote Wealth Management in Cedar Rapids, Iowa. “While home equity does make up the majority of many American's net worth, you should never count on being able to quickly or cheaply access that equity.”
Forbearance: ‘Anyone who needs it can get it’
As part of the coronavirus relief legislation called the CARES Act, homeowners with federally backed mortgages can request forbearance for up to a year, without fear of foreclosure. So far, forbearance requests have reached 3.8 million, according to the Mortgage Bankers Association.
“It was very quickly done overnight and anyone who needs it can get it, opening up this huge unprecedented amount of people who could apply for forbearance,” said Brian Koss, executive vice president at Mortgage Network.
Fannie Mae and Freddie Mac have promised to buy loans in forbearance from lenders to help keep the mortgage market working. But they refuse to purchase mortgages in forbearance that were cash-out refinances, making those types of loans riskier for lenders to originate and carry.
As a result, lenders are upping their standards for these loans.
Mortgage company PennyMac announced in late April that it won’t do any cash-out refinances that exceed 80% of the property’s market value.
Cardinal Finance, a mortgage lender in North Carolina, recently said it would only accept borrowers for cash-out refinances whose total monthly expenses are 36% or less of their gross monthly income, a more conservative standard than before.
‘We may have declining real estate’
Lenders also worry about Americans’ ability to pay back loans at a time when an unprecedented number of workers have filed jobless claims in the last seven weeks.
They also expect property values could dip, especially if the economy falls into a recession, increasing their risk on mortgages and other house-backed loans they hold.
That’s caused major banks to pull back on issuing new home equity lines of credit, or HELOCs. Both Chase and Wells Fargo recently announced they would pause new HELOC applications.
Lenders worry a borrower who becomes unemployed could default on the payments at the same time that home values are decreasing, eroding even more equity. If the lender is forced to foreclose and sell the home, it may not recoup what’s owed.
“The lenders will have no profit,” said Kevin Leibowitz, founder of Grayton Mortgage. “The guy in the second position isn’t crazy to think that 10% can be wiped away.”
Turning to other funds instead
Financial planners often advise clients to tap their home equity when they run into financial trouble, instead of turning to other costlier types of debt such as credit cards or raiding their long-term retirement savings.
“With HELOCs, at the end of the day, you’re drawing debt that is cheaper, a little above 4% interest rate, while credit cards are averaging 16%,” said Dan Slagle, founding partner at Fyooz financial planning.
But as that well runs dry, Americans may have no choice but to liquidate or borrow from other assets such as their taxable investment accounts or their retirement funds.
“Some of the clients we have, such as dentists, are getting crushed and so we start liquidating funds from their stock portfolios,” said Charles Failla, principal at Sovereign Financial Group. “We also take advantage of the CARES Act and consider withdrawing funds [from their 401(k)s] as long as they pay it back under three years to avoid the tax consequences.”
Fidelity reported that 165,000 investors took a hardship withdrawal during April, or three-quarters of the total number of withdrawals reported for the entire first quarter. But these withdrawals threaten the long-term security for many Americans who are already behind on retirement saving.
But they may have no other choice in today’s home equity environment.
“It is always a good idea to build up a sizable emergency savings before paying any extra payments on your mortgage to ensure you have savings available when you need it most,” Hylland said. “If you are dependent on debt to make ends meet you should be aware that at times you need it most, debt financing may not be there for you."