One of the big changes in the tax measure President Trump signed last month could make it less attractive for homeowners to borrow against their properties to fund fix-up projects, pay off credit cards or buy a new car.
For decades, home equity loans have been a popular vehicle for homeowners to fund big-ticket expenditures, partly because the interest on the loans was deductible. But the new tax law wipes out that deduction, both on future loans and on money people have already borrowed.
The change will cost the average home equity borrower thousands of dollars in taxes over time. But it also reduces an incentive to borrow money that emerged as a major problem in the last recession, when many homeowners piled up unmanageable levels of debt only to see property values plunge.
“This is a policy that removes the incentive to treat your home equity as an ATM,” said Daren Blomquist, senior vice president of communications for Attom Data Solutions, a real estate information company.
The change comes at a time when home equity is soaring and homeowners are spending record amounts of cash on improvements. During the third quarter of 2017 alone, there were 5,970 new equity loans in the Twin Cities, just shy of an all-time high.
The Joint Center for Housing Studies at Harvard University says that by the third quarter of this year homeowners nationwide are expected to spend $330 million on remodeling projects, a 7.7 percent increase over last year and an all-time high.
In the Twin Cities, two factors are driving the trend. Home prices are at record highs, so a lot of homeowners can qualify for equity lines, under which the borrower can take out money up to an authorized limit. At least one in four homeowners in the Twin Cities is now considered equity rich, according to Attom, with at least 50 percent equity in their home.
At the same time, there are relatively few homes for sale, especially at the low end of the market. That is leading people who might in the past have looked to buy a nicer house to instead borrow to spruce up the property they already own.
Under the new tax laws, however, home equity loans won’t be quite as attractive. Blomquist said the average metro-area borrower has a $145,117 line of credit and has typically drawn down about half of that at any given time. At current interest rates, a borrower with a balance a little over $70,000 would be able to deduct more than $3,000 in interest under the old rules.
“That tax deduction made home equity appear even more favorable as a borrower option,” said Greg McBride, chief analyst at Bankrate.com. “Now it’s on the same footing as everything else.”
Cristian deRitis, senior director and economist at Moody’s, echoed the idea that reducing the tax incentive for homeowners to borrow could help make it less likely that people will take on more debt than they can manage.
“The change in the tax law should be a small positive in the long run as it removes some of the incentive for households to borrow against their home equity for short-term consumption as occurred during the housing boom,” deRitis said.
But McBride pointed out that even without any tax advantage, equity loans will remain attractive for many people who need to borrow.
“It’s still cheaper than a credit card,” McBride said. “If you put a $30,000 addition on your home, it’s still going to be a favorable way to borrow.”
For many homeowners, the full impact of tax reform won’t be clear until they file their 2017 taxes, according to local mortgage brokers. But economists expect consumer borrowing habits to change dramatically as interest rates rise from current, historically low levels.
There are indications that’s already happening. After recent increases in mortgage rates, refinancings are falling.
Keith Gumbinger, vice president with HSH.com, said the days of using home equity for debt consolidation and payment relief on high-interest credit cards are probably over.
“After so many years of homeowners having no equity,” Gumbinger said, “the rules have changed to deter the use of home equity as a household budget management tool.”