Homeowners who snagged a low-interest rate mortgage in recent years have a big incentive to avoid refinancing the loan because interest rates are higher now. When they need a large amount of cash, though, some homeowners are turning to cash-out refinancing — even if it means giving up a lower rate in the process.
In the past five years, the cash-out share of refinance transactions has jumped from 13.9 percent in 2013 to 41.5 percent by September 2018, according to data from CoreLogic. The trend follows the increase in home values and tappable equity, which is the amount homeowners with a mortgage can borrow before reaching the maximum 80 percent loan-to-value ratio.
By the end of October 2018, homeowners with mortgages had access to $5.9 trillion in tappable home equity, down $140 billion in the third quarter from the previous quarter, according to data from Black Knight.
To find out where the most Americans are using cash-out refinancing, we asked CoreLogic to look at data for the past decade. Here’s a snapshot of the top 10 housing markets where the cash-out share of refinancing has expanded most in recent years.
For some, cash-out refinancing has acceptable tradeoffs
Sacrificing a lower interest rate for a higher one to get cash is a price some homeowners are willing to pay to access their home’s equity — even if it means paying more interest in the long run.
Mortgage broker Jovan Vaughn says clients in his Laguna Hills, California, market want to get the most out of their equity while they can to improve their financial footing.
“People used to want to know the max amount they could pull out and how quickly they could get it,” Vaughn says. “Now, they come in wanting a certain amount for a certain purpose.”
Cash-out refinancing for home improvements will see a modest boost in activity in the year ahead, especially with rising home prices and mortgage rates in the forecast, says Len Kiefer, deputy chief economist with Freddie Mac.
Other factors, like paying down high-interest debt and economic uncertainty, could play a role in cash-out refinancing. Forecasts for slower economic growth this year, along with recent stock volatility, may further rattle consumers.
“People are more worried about paying off things before a recession hits and they lose a job,” Vaughn says.
Cash-out refinancing could lose favor
Homeowners in some states — with California leading the pack — are seeing their tappable equity dwindle as home-price growth contracts. Add in higher mortgage rates that are forecast for 2019, and cash-out refinancing becomes less attractive.
Tapping home equity, compared to other types of borrowing, can be the least-expensive way for someone to pay for a home improvement, pay off other debt, or invest in a business, says Mike Fratantoni, chief economist with the Mortgage Bankers Association.
Although the share of cash-out refinancing is on the upswing, the amount of tappable equity people are actually pulling out continues to drop. In Q3 2018, just $64 billion in equity was withdrawn through home equity line of credits or cash-out refinancing, Black Knight reported. That’s down 8 percent from the second quarter and 10 percent lower than a year ago.
Homeowners might be holding back because of the role home equity lending played in the housing crisis a decade ago. Another reason: more workers are saving a bigger chunk of their income in proportion to income spent, Fratantoni says. Before the housing crisis, the proportion of income saved to income spent was “hovering around zero,” Fratantoni says. Today, it averages about 6 percent, he says.
“Certainly people are borrowing, but they’re also saving in a way they weren’t previously,” Fratantoni says.
Alternatives to cash-out refinancing
Doing a cash-out refinance is one way to turn your home equity into cash. Other ways of converting equity into cash are:
- Home equity line of credit, or HELOC
- Home equity loan
- Reverse mortgage
A home equity line of credit works like a credit card, with your house as collateral. You have a credit limit, just as you do with a credit card, and you can spend up to that limit. The interest rate moves up and down with the prime rate.
A home equity loan is a lump-sum loan with a fixed interest rate.
A reverse mortgage allows homeowners age 62 and up to draw cash from their homes in various ways. The balance doesn’t have to be repaid as long as the borrower lives in the home and stays on top of homeowner’s insurance and property tax payments.
Ideally, you want to save up for large, unexpected expenses in an emergency fund rather than treating your home as a piggy bank. Home equity is one of many tools to help you meet your financial goals, but it should be used thoughtfully and with discipline.
Before considering a cash-out refinance, ask your mortgage lender to help you figure out how the change in interest rate and borrowing costs stacks up against what financial benefit you’ll gain from the cash withdrawal. Set a clear strategy for how a cash-out can help improve your overall financial picture.