That represents an annual increase of 31.1 percent, the largest average gain in more than 11 years and three times the pre-pandemic gain in equity between the third quarter of 2019 and the third quarter of 2020.
“Homeowners have an enormous amount of home equity wealth driven by double-digit home price growth,” says Frank Nothaft,chief economist of Irvine, Calif.-based CoreLogic. “In high-cost housing markets, the amount of equity gained has been higher than the national average, going up to as much as $119,000 in California, for example.”
As a result of increased home values, lenders and real estate data analysts say that cash-out refinancing, which allows borrowers to take out some of their home equity with a new mortgage, increased in 2021. That growth is anticipated to continue in 2022.
Should you refinance your mortgage now? Factors to consider.
“I think it’s inevitable that we’ll see more cash-out refinancing in 2022 because homeowners have experienced continual home equity growth over almost the past 10 years,” says Rick Sharga, executive vice president of RealtyTrac, a division of Attom, a property data and analytics firm based in Irvine. “We’ve also seen a trend that homeowners are staying in their homes longer, especially baby boomers who want to age in place. Instead of selling after three to five years like people did a decade ago, homeowners are more likely to tap into their equity to remodel.”
Mortgage rates are anticipated to increase in 2022, which Sharga says means lenders may need to market cash-out refinancing as a way to offset a lower number of purchase loans and traditional refinances.
“I expect we’ll see some lenders target their marketing to making home improvements and paying off credit card debt or student loan debt with a refinance,” Sharga says. “They may offer lower rates, lower points on the loan and lower closing costs as incentives.”
Paul Buege, president and chief operating officer of Inlanta Mortgage in Menomonee Falls, Wis., says about 50 percent of refinances completed by his company were cash-out refinances during the third and fourth quarters of 2021. Most were homeowners using the funds to make home improvements.
“We closed 33 percent more cash-out refinance loans in 2021 compared to 2020 and we expect that growth to be sustained in 2022,” says John W. Mallett, founder of MainStreet Mortgage and author of “Buy Your First Home Today,” who is based in Westlake Village, Calif. “While there are lots of homeowners who see their home value rising and want to pay off their loan even faster before they retire, some want to take out cash to fix up their house and make it better. Others have debt they want to pay off to improve their finances.”
Options to cash out your home equity
The two most popular options for tapping into your home equity are a cash-out refinance or a home equity line of credit, known as a HELOC.
“Tappable home equity” refers to your home equity above 20 percent. Most lenders today will only loan a maximum of 80 percent in your home’s equity, although a few may allow a loan-to-value of 85 percent for borrowers with excellent credit and a strong financial history. For example, if your house is worth $500,000, you can borrow up to $400,000. If you owe $350,000, you could increase your balance and take out up to $50,000 if you qualify for a cash-out refinance.
“Many homeowners today have 30 or 40 percent or more in home equity because of the rapid increase in home values,” Nothaft says.
A cash-out refinance replaces your existing loan with a new mortgage at a larger balance than is owed on the house, with the difference paid in cash, says Sean Grzebin,head of consumer originations for Chase Home Lending, who is based in Jacksonville, Fla.
However, a cash-out refinance typically has a slightly higher interest rate than a traditional refinance. Borrowers pay closing costs and fees and are likely to have higher mortgage payments because of the larger loan balance.
How to refinance your mortgage, a step-by-step guide
“A cash-out refinance replaces an existing mortgage, whereas a HELOC exists as a separate loan, creating a second lien on the property,” Grzebin says. “Some consumers may opt for a cash-out refinance instead of a HELOC to avoid having multiple liens on their home.
Moreover, customers choosing a cash-out refinance will have just one payment that is generally a fixed rate vs. a variable rate. It’s also fully amortized, meaning there is no balloon payment expected after 10 years, which many HELOCs have. Taken together, these features can make a cash-out refinance an option that customers may find more predictable and easier to manage than a HELOC.
A HELOC often carries a higher interest rate than a refinance because it is a second loan and therefore considered riskier by lenders. Borrowers usually pay little to nothing in fees for a HELOC and can use as much or as little of the line of credit as they want. Payments are only required on the amount of the HELOC used.
“One caveat about HELOCs is that when home values dropped after the housing crisis, many lenders shut down homeowners’ lines of credit,” Sharga says. “There’s no expectation that prices will drop that way again, but there’s always a possibility that it could happen.”
A HELOC typically has an adjustable interest rate and requires borrowers to only pay the interest on the debt for 10 years. Borrowers can experience payment shock at the end of that time when they must pay both principal and interest and could be paying a higher interest rate, Mallett says.
Avoiding housing crash 2.0
One concern about an increase in cash-out refinancing is the possibility of another housing crisis similar to 2007-2008 when millions of Americans lost their homes in a foreclosure or short sale.
“An underreported aspect of the mortgage meltdown was the role of cash-out refinancing in the high number of foreclosures,” RealtyTrac’s Sharga says. “Borrowers used their homes as an ATM to pay for daily expenses, vacations and cars, so when values dropped, they were deeper underwater on their mortgages.”
Today, most lenders only allow homeowners to borrow up to 80 percent of their home’s value, so they keep 20 percent in home equity.
“You don’t see loans for 100 percent of the home value anymore,” Sharga says. “Whether it’s because of new regulations, lessons learned or a combination of both, lenders are far more conservative than they were before the housing crisis.”
Should you refinance your home to pay down your student loans?
Unlike before the housing crisis, lenders are required to fully document every mortgage application to ensure the borrowers can repay the loan, Buege says.
“Everyone must qualify for a cash-out refinance based on their credit score and their debt-to-income ratio,” Buege says. Your debt-to-income ratio compares the minimum monthly payment on all recurring debt to your gross income. “Lenders use much more disciplined credit standards today.”
In addition, CoreLogic’s Nothaft points out, the housing market is far different now than it was leading up to the Great Recession.
“In 2006 we had an overbuilt housing market and builders were continuing to add supply,” Nothaft says. “Today, we are severely underbuilt and have generationally low vacancy rates for all types of housing. That will sustain prices so we’re far less likely to see a drop in home values.”
Still, some lenders continue to be wary about the overuse of home equity, particularly for debt consolidation.
“Cash-out refinancing can be addictive,” MainStreet Mortgage’s Mallett says. “It’s easy to see that if you have $50,000 in credit card [payments] at a high interest rate you can improve your cash flow by paying it off with cash from your house. But some people are tempted to go out and take on more credit card debt.”
However, regulations and lender concerns about a repeat of the foreclosure crisis make it far more difficult today to repeatedly take equity from your home.
For many homeowners, cash-out refinancing offers an option to pay for home improvements that could result in a higher home value and a better quality of life.
“One reason for the increase in cash-out refinancing is the time everyone has been spending in their homes during the past couple of years,” Buege says. “People are taking cash out of their homes to improve their work-from-home setup and their outdoor space.”
Cash-out refinancing is more popular for specific projects, such as home improvements that require a lump sum of money, than a line of credit.
‘Recasting’ is another way, besides refinancing, to save money on your mortgage
“Even if you pull out money to put in a pool, which may not give you a great return on investment, it can be transformational for your family if it means your kids and their friends spend more time with you,” Mallett says.
Buege says debt consolidation to eliminate credit card debt or student loan debt is also common.
“If you’re going to use your equity to pay off debt, you need to make structural changes to your finances,” Mallett says.
Funds from a cash-out refinance can also be used to buy out a share of a property from a co-owner, such as in the case of a divorce, Grzebin says.
Qualifying for cash-out refinance
Exact qualifications vary from one lender to another. Still, many lenders require a credit score of 680 or higher for a cash-out refinance, Inlanta Mortgage’s Buege says. Generally, a debt-to-income ratio of 45 percent or lower is also required.
“Compared to a standard refinance, cash-out refinances typically require a higher credit score and lower loan-to-value ratio to ensure a customer’s ability to repay the loan with higher monthly mortgage payments,” Grzebin, of Chase, says. A loan-to-value ratio compares your loan balance with your appraised home value. Some lenders refinance loans with a ratio higher than 80 percent if the borrowers are not tapping their home equity.
Any homeowner considering a cash-out refinance or a HELOC should consult a lender to discuss the pros and cons of all their options, Buege says.
“Home equity is a significant source of financial security and intergenerational wealth,” Sharga says. “Just because you have it doesn’t mean that you need to use it. Consumers need to think twice about taking out their equity, especially because it can be an important part of their retirement.”
A look at shared equity option
The pandemic’s uneven impact on people left many homeowners equity rich but cash poor. Some homeowners who lost their jobs and lost family members who shared expenses continue to struggle financially but cannot qualify for a cash-out refinance because of a lower credit score or the inability to qualify to make payments on a new loan.
One option for some of these borrowers is a shared equity arrangement from companies such as Hometap, Unison and Unlock. Unlike a cash-out refinance or a home equity line of credit, a home equity share agreement allows homeowners to take out cash from their home equity without payments or interest accruing. In exchange, the investor will be repaid with a portion of the home’s equity when the homeowners sell, buy out the investor or the agreement ends.
“A shared home equity agreement gives homeowners an opportunity to access their equity even if they have a credit score as low as 500,” says Michael Micheletti, head of communications for Unlock. “This isn’t a loan, so there aren’t any payments either. Most of our customers are using the money to wipe out their other debts and get in a better cash flow position.”
Investors in shared equity agreements gain access to residential real estate without actually becoming a landlord, Micheletti says.
“Most of our homeowner customers expect to refinance within a year or two after their financial situation stabilizes and their credit score improves,” he says. “They can buy back their equity when they refinance or sell their home. They can also buy it back in increments.”
At Unlock, homeowners are evaluated monthly to make sure they are making their mortgage payments. To protect investors and homeowners, all liens on the property such as for unpaid taxes or homeowner association dues must be paid with some of the equity initially taken from the home. In some cases, especially for borrowers with a credit score under 550, other debts must also be directly paid from the equity share.
“We want to secure the house from foreclosure for the investors and the homeowners,” Micheletti says.
Alternative financing arrangements such as shared equity agreements are largely unregulated so far, Sharga says.
“While they offer an opportunity for homeowners to tap into their equity who might not otherwise be able to do so, consumers need to approach these with their eyes wide open to make sure they understand the consequences of the agreement,” he says.