For most people, their homes are the largest financial asset they own. But homeownership can also be risky for households, especially if they are not prepared for the unexpected.
Fortunately, there are many ways to prepare for unexpected events and minimize the impact on homeowners. Here are some crucial financial protections for US homeowners heading into 2023.
- Homeowners Insurance
Homeowners insurance provides financial protection for consumers’ homes and personal belongings in the event of a loss. It can also cover liability from injuries or damage to others that occur on the property. Typically, a policy will reimburse for the cost to repair or rebuild on an actual-cash-value basis, minus any deductions for depreciation and wear. Depending on the policy, it may also include replacement value coverage that pays up to the insured’s maximum limit in the event of a total loss. Remember the cost of home warranty is different from the cost of homeowners insurance. Be sure you understand the difference between the two.
Inflation is a significant factor driving homeowners insurance rates up this year. Higher construction costs due to pandemic supply chain disruption and labor shortages have driven up material prices, which in turn has prompted insurers to increase premiums. However, savvy consumers can reduce their homeowners insurance costs by raising deductibles and bundling with other policies, such as auto insurance, from the same provider.
- Home Equity Loans
Homeowners who have built equity in their properties can leverage this value to obtain low-cost funds via a home equity loan or revolving home equity line of credit (HELOC). Unlike mortgages, these loans are disbursed in one lump sum and have a fixed interest rate. For this reason, home equity loans are better suited to goals that require a set amount of money over a specified period such as remodeling or debt consolidation.
Another advantage is that home equity loan and HELOC interest may be tax deductible if used for qualifying purposes. However, before pursuing either option, homeowners should carefully weigh the pros and cons as well as consider alternatives that align with their financial needs. For example, they should also consider the impact of rising interest rates on their monthly payments.
- Home Equity Lines of Credit (HELOCs)
The value of a homeowner’s home can be a huge asset when it comes to financing a major renovation or consolidating debt. But before you decide to tap into your home equity, it’s important to understand what you’re getting into.
A HELOC offers a revolving credit line with a maximum borrowing limit, similar to the
maximum limit on a credit card. However, HELOCs typically come with a variable interest rate that can change monthly.
Also, a HELOC requires homeowners to use their home as collateral, so if you fail to make payments on your HELOC, the lender can foreclose on your property. To avoid these risks, it’s best to borrow money with a home equity loan or cash-out refinance instead of using a HELOC.
- Child Development Accounts (CDAs)
Child development accounts (CDAs) are savings or investment accounts opened for infants to promote long-term asset building and support families’ goals for education, entrepreneurship, home ownership, and retirement. CDAs have proven to have a wide range of positive financial and nonfinancial impacts on households, with particularly significant effects among low-wealth and families of color.
Research from the SEED national initiative, including MI-SEED, suggests that a universal CDA policy model can reach families across the socioeconomic spectrum, significantly reduce household wealth disparities, and boost child development. To achieve inclusive policy at scale, it is important to ensure that CDAs are automatically enrolled and avoid the need for parents to opt in.
State birth records provide the best centralized source of information to enable automatic, universal enrollment and maximize asset growth potential over time.
- Mortgage Interest Deduction (MID)
Proponents argue that the MID incentivizes homeownership, which has been associated with a host of benefits for households, neighborhoods, and the economy. In reality, the MID is a regressive subsidy that disproportionately benefits higher income homeowners who can afford more expensive homes and take out larger mortgages.
The MID also distorts housing markets, incentivizing homeowners to stay in their homes as long as possible, which increases mortgage rates and reduces home values. Moreover, the MID is costly: in 2019 alone, homeownership subsidies including the MID cost the federal government nearly $196 billion.
Given these problems, Congress should consider converting the existing deduction into a credit for new and current homeowners. This reform would help more lower and middle-income households than the existing deduction, while eliminating or scaling back subsidies for high-income homeowners.