So-called cash-out refinances are surging in popularity, hitting heights that haven’t been seen in over a decade, since the Great Recession of the 2000s.
Economists say they’re not concerned by the trend though, as the housing market is still going strong and home prices are rising. During the Great Recession, cash-out refis grew at a time when home prices were falling fast, the Wall Street Journal reported.
A cash-out refinancing makes it possible for homeowners to swap the equity in their homes for a lump sum of cash. Basically, they agree a deal with the bank to pay off their old mortgage with a new one, and keep the extra cash that’s left over. It can often amount to thousands of dollars, depending on the equity the homeowner holds.
Cash-out refis jumped 42% in 2020 compared to the year before, according to data from Freddie Mac. Altogether, homeowners cashed out $152.7 billion of home equity, the highest amount since 2007.
Experts say that the current record low mortgage rates are one reason for the rise in cash-out refis. With mortgage rates so low, it’s possible to obtain a nice lump sum of cash and also organize cheaper repayments with the new mortgage. Meanwhile, home equity has been on the rise as home values have gained by double-digits in the last year.
Daryl Fairweather, chief economist at real estate brokerage Redfin Corp., told the Journal that many homeowners are taking advantage of the low rates to afford larger homes, second homes or spend the equity on home renovations.
"There are genuinely a lot of people who want to buy homes to live in," he said. "They're not just buying them to buy them or speculating that home prices will continue to rise. People are buying because they want them and they're not trying to sell again the next year."
The amount of money available from tapping into homeowner equity can be tempting. Borrowers who took out a cash-out refinance last year withdrew $50,000 on average, down from $59,000 one year ago, the New York Federal Reserve office reported.
Still, financial experts advise caution when considering cash-out refinancing. Not only does it tie them homeowners to a much longer mortgage duration, but it could also mean they pay more in interest over the long run. In addition, homeowners need to consider the potential tax implications. A 2017 overhaul to tax rules means that borrowers cannot deduct the interest on the cash-out portion of the refi unless that money is being used to improve their home.
Growth in cash-out refinancing was a big cause of concern in the run-up to the 2008 financial crisis as borrowers sought refuge in their homes to generate extra finance. But when home prices fell, it left many owing more on their homes than what they were worth, followed by a wave of defaults and resulting foreclosures.