Wise and Not So Wise Refinancing Choices



With homes steadily and rapidly appreciating in value for several years, refinancing is alive and well, even if it isn’t in the news very frequently. A blast form the past – cash-out refinancing peaked in 2006, when homeowners cashed out $320.5 billion in total home equity volume, according to Freddie Mac’s Cash-Out Refinance Report. Then the bottom fell out of home values to send many mortgages underwater resulting in practically no home equity being available for many years.

Today, home equity is again alive and well. And so is refinancing. As of March 2019, Freddie Mac says U.S. households own real estate worth over $25 trillion. Mortgage debt is $10 trillion, leaving $15 trillion in net homeowner equity.

Statistics show that the number of refinance loans being taken out is near the historical highs of 2006 before the bottom fell out of home equity. Although the number of loans is high, the dollar value of the loans is not near historical highs. Adjusted for inflation, in the fourth quarter 2018, an estimated $14.8 billion in net home equity was cashed out. Down from the $20.4 billion a year earlier and substantially less than the peak cash-out refinance value of $104.8 billion during the second quarter of 2006.

Many Cash Reasons

According to CoreLogic data, the average homeowner gained $6,400 in annual home equity the first quarter of 2019 compared to the first quarter of 2018. That may seem substantial but it’s off considerably from the $9,700 annual gain the year before. Value appreciation is slowing. At the same time, interest rates have been rising.

Generally, refinancing was not done to lower the interest rate. Rather, homeowners were willing to pay higher interest in order to access money for other purposes. One noteworthy statistic is that 94% of borrowers who had a hybrid ARM chose to refinance into a fixed-rate loan during the fourth quarter. That’s a good thing when interest rates are rising.

Other recent data shows 40% of the money was used to pay down other higher interest debt or pay other bills. The next 31% went towards home repairs and construction. Other uses for the money were 14% into savings, 9% for other major purchases such as autos, 7% for college expenses, and 6% for business or other investments.

Wise Use of Equity?

Paying off credit card debt and taking big vacations is the most common reason for cash out refinancing. Reality is that you’ll be financing that vacation for the next 20 or 30 years with a new mortgage. Even worse, too many consumers just run credit card debt back up to new highs after the refinancing pay off.

Home remodeling is also popular. The hope of many people is that a renovation will increase the value of the home. However, reality is that you are better off renovating with the goal of making your home more attractive and more functional for your own needs. According to Review Remodeling magazine, the average bathroom addition pays back slightly less than 60% of the total cost. The exception is if you add a second bathroom to an older single bathroom home. A $50,000 kitchen remodel may please you as a gourmet cook but it won’t add anything near that amount to your home’s value.

If you can’t afford a fancy new car on your existing income, it’s probably not financially wise to cash in your equity to buy one. Unlike your home, the car will depreciate rather than increase in value. In fact, you aren’t even likely to save on the interest rate since most new car loans cost less than home equity loans or lines of credit. The same goes for other high-end luxuries like boats and RVs.

College and Real Estate Investing Makes Some Financial Sense

Rehabbing to flip another house or becoming a landlord can be ways to use your equity to increase your wealth. But first, be sure you have the skills and knowledge to be successful. Among the many financing options are taking out a new mortgage secured by the investment property or refinancing your primary home to pay cash for the investment. Taking out a separate investment mortgage comes with a higher interest rate and qualifying is more difficult compared to refinancing your own home.

Investors are more likely to default on an investment property than their primary home. Therefore, lenders typically demand a higher interest rate and a high down payment. Investing with all cash by refinancing can be a good choice as long as the higher monthly payment on your own home doesn’t jeopardize losing your home.

Financing your children’s college education is a combination of emotional and financial prudence. On the upside, home equity loan rates can be less than college loans along with the paid interest on a home equity loan being tax deductible. On the downside, you put your home on the line for your children’s education. When the children take out college loans, these often come with flexibility during times of financial hardship. Federal student loans are eligible for loan deferments, forbearance, and sometimes even loan forgiveness.

Cash-out refinancing is one of many ways you access your home’s equity. Just be sure you learned your lesson from the housing downturn and Great Recession. Home values generally rise but can fall in value. Use your greatest asset wisely. Please share by leaving a comment. Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to askbrian@realtybiznews.com.

Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, near a national and the Pacific Ocean.