Cash-out refinancing, when borrowers trade an existing mortgage for a bigger one and then pocket the difference, reached the highest level last year since the 2008 financial crisis. With home prices appreciating during the coronavirus pandemic, it’s actually surprising that it isn’t happening even more often. It should.
Many homeowners worry too much about being overleveraged and kicked out of their homes, as millions were after the bursting of the 2007 housing bubble. Many borrowers say they’d prefer to get a personal loan at a higher rate than have one tied to their homes.
Bloomberg News
But the reality is that using a home to get cash carries much lower risks now than during the run-up to the crisis.
To begin with, consider the economic environment. U.S. home equity (the difference between a home’s value and the outstanding mortgage) totaled more than $22 trillion at the end of 2020 — almost double the amount of outstanding mortgage debt, according to Fed data compiled by the Urban Institute. In contrast, debt was about the same in 2007, while home equity was just $13 trillion.
Home prices have continued to surge, and it’s reasonable to expect the housing supply shortage to keep values from collapsing in the foreseeable future.
Another notable difference: Americans were saving about 13% of their income at the end of last year compared to just 3% in 2007. For many borrowers, a home is no longer their only major asset.
And there are important protections in place against borrowing too much, such as 80% loan-to-value ratios (meaning a loan can’t exceed 80% of the home’s value) and more rigorous documentation requirements, to prevent lenders from saddling customers with more debt than they can afford to repay. A study of lending in Texas, where the loan-to-value ratio was 80% even before 2008, shows that homeowners had lower rates of default there than in the rest of the country.
Data so far on borrowers doing cash-out refis also indicates that there’s nothing alarming going on. Homeowners are cashing out lower amounts and paying less to do so, too. At the end of last year, borrowers extracted only about 0.25 percentage points of their home’s available equity, compared to more than 0.5 percentage points in 2006.
While there isn’t any up-to-date information about what borrowers are doing with their funds, anecdotally it appears that most are focusing on home renovations and repairs, or paying off credit-card or other debt. In the mid-2000s, by contrast, many homeowners were using cash-out refis for speculative activities like flipping houses.
So if you need cash, go ahead and refinance your mortgage. A few things to keep in mind, though. Be sure to read the disclosures, which are clearer than they used to be, so you know all of the fees (they vary by state) and closing costs associated with the refinancing. When borrowers do a cash-out refi they are effectively taking out a new mortgage and beginning the life of the loan again, so weigh the interest you’ll pay during the additional years against the lower rate.
For some people, a home equity line of credit may carry lower costs than a cash-out refi, though the former generally comes with an adjustable rate. Many banks remain wary of extending home-equity credit lines, saving them for borrowers with high incomes or rarefied credit scores.
Remember, too, that if you’re deferring mortgage payments under the terms of a pandemic-relief law passed by Congress last year, you can’t refinance. And a provision in the 2017 tax law says borrowers can’t deduct the interest they pay on a cash-out refi unless the money is used for home renovations.
Interest rates are starting to increase, but they’re still low by historic standards. There are plenty of borrowers with mortgage rates above 4% who have worthwhile uses for the cash and would benefit from refinancing. If you’re one of them, don’t let unwarranted concern keep you on the sidelines.
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