Many Americans are suddenly wealthy in the house. On paper, anyway.
Soaring home prices have resulted in a record amount of available equity. At the end of last year, about 46 million homeowners held a total of $7.3 trillion in equity to leverage, the highest amount on record, according to Black Knight, a mortgage technology and research firm. – the equivalent of approximately $158,000, on average, per owner. .
This, combined with near record low mortgage interest rates, has caused an increasing number of borrowers to withdraw cash from their homes.
In the first quarter of 2021, the amount of home equity cashed in rose to $49.6 billion — the highest level since 2007, during the last housing boom. Including home equity lines of credit, Americans have taken out a total of $70.4 billion in the past few months alone, according to the most recent data from Freddie Mac.
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Although the volume of cash inflows is the highest in nearly 15 years, considering owners’ net worth, “the amount cashed in is quite modest,” said Len Kiefer, deputy chief economist at Freddie Mac.
However, it is not always easy to access this money. Since the start of the Covid pandemic, the whole industry has tightened access to mortgages and several major banks have stopped offering home equity lines of credit and cash refinances to reduce their exposure – or their risk – in times of economic uncertainty.
Until last year, a HELOC, which is a revolving line of credit but with better rates than a credit card, was a popular way to borrow against the equity you’ve accumulated in your home.
The average interest rate on this type of credit is 4.86%, according to Bankrate.com. Meanwhile, credit cards charge almost 16%, on average.
Some banks still offer this option, although most have tightened their standards, at least somewhat. This means homeowners must have higher credit scores and lower debt ratios.
“Generally, the higher your credit score, the easier it will be to access the equity in your property,” said LendingTree chief economist Tendayi Kapfidze.
There is, however, a better way to free up some of that money, he added.
“Because interest rates are so low, your best bet will be cash refinancing,” Kapfidze said. “Rates are lower than a home loan and lower than your current mortgage rate.”
Homeowners may also be able to deduct interest on the first $750,000 of the new mortgage if withdrawal funds are used to make capital improvements (although fewer people are detailing now, most households won’t benefit of this radiation).
This works well when mortgage rates drop because even if you refinance your current mortgage and take out a larger mortgage, you’re reducing your interest payment at the same time.
“Substantial opportunities continue to exist today, as nearly $2 trillion in conforming mortgages have the ability to refinance and reduce their interest rate by at least half a percentage point,” said said Sam Khater, chief economist at Freddie Mac, in a recent statement.
“If you haven’t looked at interest rates in the past year, now would be a great time to check this out,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York.
On a 30-year mortgage, rates below 3% are still widely available. “Even those who received fairly low rates now find themselves refinancing at lower rates,” Boneparth said.
Still, the most preferable terms go to borrowers with high credit scores. “Most people have decent credit, but the best rates go to those with 740 or more,” added Greg McBride, chief financial analyst at Bankrate.com.
Of course, there are also some limitations for cash refinances.
To start, most lenders will require that you keep at least 20% of your home’s equity, if not more, as a cushion in case house prices drop.
“It’s not 2005, you can’t cash out every last penny you have at home,” McBride added.
Additionally, a cash-out refinance often means extending your repayment term, which can reduce your monthly budget in the long run, while having to pay closing costs up front.
Generally, “if you can cut your rate in half to three-quarters of a percentage point, it’s worth looking into,” McBride said. “That’s usually the tipping point.”
Then “you can recoup your costs in a year and a half,” he said, and “refinancing becomes very attractive.”
Finally, refinancing opportunities could be short-lived. Mortgage rates won’t stay low forever, especially as inflation rises.
“That should add some urgency to getting a refinance done sooner rather than later,” McBride said. “The economy is heating up – these are the conditions that are producing higher mortgage rates.”