Economic uncertainty abounds right now as inflation rises and interest rates on all kinds of financial products rise.
Even so, homeowners may find that tapping into their home’s equity through a cash refinance is a financially smart move, despite costing more than it did a year ago, or even two months.
Here’s why a cash-out refi can still make sense, even in this economy.
What’s Happening With Mortgage Refinance Rates
It’s no secret that mortgage rates have been rising rapidly. At the start of 2022, the average interest rate for a 30-year fixed mortgage for a purchase was less than 3.5%. Now, less than six months later, that average has climbed about two percentage points, hovering around 5.5%. Although refinance rates are a little lower than these purchase rates, they have followed a similar upward trend.
“That’s a huge increase,” says Joel Kan, associate vice president of economic and industry forecasting at the Mortgage Bankers Association (MBA), adding that it’s led many homeowners to forgo refinancing.
“Refinances are down 70% year over year,” Kan says. “After two years of record refinancing, 2020 and 2021, where people got a fixed rate below 3.5%, there really isn’t much upside to refinancing.”
He adds that mortgage rates are expected to average 5% for 2022 based on current MBA analysis. Even at these higher levels, many homeowners could take advantage of a cheaper mortgage.
“There are still millions of consumers using mortgage products where they can lower their interest rates by refinancing,” says Joe Mellman, senior vice president of mortgage operations at TransUnion, though he acknowledges that number is much weaker than it was during the 2020 and 2021 refinancing wave.
“While that 5% from a long-term historical perspective is still quite low, it’s significant because it’s up to 60% higher than the rates at which consumers have locked themselves in their refinance,” he said. they’ve undertaken one in recent years, Mellman says.
Why Homeowners Could Still Benefit From Cash Refinance
For most homeowners, a rate and term refinance doesn’t make sense given today’s rate environment, but cash refinances can still be a great option for many.
Tapping into your home’s equity can be a great way to consolidate higher-interest debt or fund expensive projects like home repairs.
“Home improvement is another major use of home equity, as many more consumers work from home and have a renewed interest in investing in their homes,” Mellman said. “Home equity is one of the cheapest ways to fund that home improvement.”
Because home prices have soared in recent years, homeowners are sitting on record levels of equity: a total of $20 trillion in usable equity currently, TransUnion estimates.
“Especially with inflation on a tear, that means consumers are putting more on credit cards and they’re putting more on personal loans, which are absolutely standard things that we see when inflation goes up,” Mellman says, adding that taking advantage of all that spare capital can make some of these bridge financing tactics more affordable.
However, Kan says it’s important for owners to really weigh the numbers before dipping into their capital.
“There’s a lot of financial gymnastics involved,” says Kan. “For some people, getting cash out is definitely a better choice than funding it with a credit card or other means, but they need to be able to stay current and qualify for that mortgage. “
Alternatives to Collection Refis
Especially with the upward trend in mortgage rates, homeowners looking to leverage their capital may want to consider other options, such as home equity lines of credit (HELOCs) or home equity loans.
“For a cash-out refi, you’re not just refinancing the cash-out portion, but you’re refinancing all of the existing debt,” says Mellman. “I would be very cautious about raising your rate on the main mortgage just to get a lower rate” on your principal.
HELOCs and home equity loans allow you to keep your main mortgage in place – so if you have a 3% interest rate in the age of the pandemic, you can exploit your principal without increasing the monthly payment of this original loan.
But HELOCs and home equity loans also have drawbacks.
HELOCs, for example, allow you to draw on your equity as needed, but often have variable interest rates, so your monthly payments can be unpredictable. Home equity loans, on the other hand, are a lump sum payment separate from your main mortgage, which can add an extra layer of complexity to your monthly budget.
“Consumers need to weigh a few things: whether they need a large sum of money right away or whether they want a rainy day fund to draw on over a period of time,” Mellman says.
Whichever equity option you choose, adds Kan, it’s important to budget for it in advance and make sure you can afford the new payments.
At the end of the line
Even though interest rates are rising everywhere, home equity products remain a relatively inexpensive form of financing. Undertaking a cash refinance or opening a HELOC or home equity loan can be much cheaper than financing a big project or buying with a credit card or using a personal loan. Because home equity products use your home as collateral, they tend to have lower interest rates than other forms of financing, but carry higher risk if you can’t make the payments.