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As mortgage interest rates stay near historic lows and home values increase, homeowners are motivated to pull out the equity in their homes at historic rates. According to Black Knight's Q3 2019 mortgage monitor report, homeowners withdrew more than $36 billion in equity between July and September of 2019 in cash-out refinancing, the highest amount in nearly 12 years. Rate-and-term refinances are 10 times more prevalent than they were just a year ago.
Are homeowners getting in over their heads?
The national average home price reached $212,426 as of October 2019, according to the S&P/Case-Shiller U.S. National Home Price Index. That's a 15 percent increase from the peak of 2006, in which the average home price was $184,614. With housing prices at an all-time high, the debate rages as to whether a recession is coming in 2020. If the real estate market experiences another recession, property values could decline rapidly as they did in the wake of the Great Recession, leaving millions of homeowners underwater again.
Cash-out refinancing makes up over half of refinances because most homeowners are able to get cash for their home's equity while receiving a lower or similar interest rate to their original mortgage loan. Home equity line of credit (HELOC) rates, however, were on average 2.9% higher than 30-year fixed rates as of Q3 2019, the largest such delta following the financial crisis.
Tappable equity has grown in 97 of the 100 largest U.S. markets over the past 12 months, yet these top-tier markets are among some of the lowest levels of cash-out refinances. Mid-tier markets among the top for year-over-year increases in home equity withdrawal include:
- St. Louis, Missouri
- Boise City, Idaho
- Memphis, Tennessee
Homeowners and investors, especially in mid-tier markets, should use cash-out refinances or HELOC loans carefully. While there may be substantial equity in the home, drawing from that equity can reset the loan schedule, resulting in more interest paid overtime because the loan is re-amortized, or create a second mortgage with an adjustable rate that can equate to a costly payment over time.
Should you pull equity?
There are times when pulling equity makes sense, like when you're using the funds to:
- Improve the property
- Consolidate higher debt elsewhere
- Purchase an income-producing property.
But the risk to reward should always be carefully calculated.
Determine whether the loan, even at a lower interest rate, will save you money in the long run. If not, is the equity withdrawal you're receiving now worth paying additional interest over time? You'll also need to calculate whether you could sustain the payment if the economy were to turn. Would the equity you receive now put you underwater if property values plummeted 30% to 50% as they did in the Great Recession?
If tapping into the equity of your home makes sense for you, reduce your risk exposure by pulling less than what might be available so you are only using what you need, and only refinance if you can secure a rate at or lower than your previous mortgage.
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