Truth About Cash-Out Refinances
The past year has been incredible for homeowners and home buyers. Home sales have gone through the roof and new homeowners, as well as existing homeowners have taken advantage of it. For the past year, Much of the reason for the demand to buy a new home has come from historically low mortgage rates. Rock bottom mortgage rates did not only result in a surge of home sales. It also led to a bunch of existing homeowners clamoring to refinance their mortgages. Mortgage refinances in 2020 were up over 100% from previous year’s levels. Beyond the fact that many decided to refinance their mortgages while rates were low, many decided to refinance for more than their previous mortgage. These types of cash-out refinances can have implications on the overall market. What do last year’s cash-out refinance numbers say about the health of the housing market?
What is a Cash-Out Mortgage Refinance?
A cash-out mortgage refinance is when a homeowner replaces a previous mortgage with a new mortgage that is for a higher amount than the previous mortgage. This then provides them cash on hand that can be used for a number of different things. Homeowners typically choose to do a cash-out refinance when the mortgage rates available drop well below the rate on their existing home loan. This sets them up to take out a larger loan than they already had while still decreasing their monthly payment.
How Many Cash-Out Refinances Happened in 2020?
Based on recently published data regarding the fourth quarter of 2020, cash-out refinances increased a lot from previous years. According to Freddie Mac, Americans took out much more in refinancing than they did in 2019. Specifically, Americans took out about $153 billion in equity through cash-out mortgage refinances in 2020. These types of numbers have not been seen since the runup to the great real estate and economic crash of 2008. In fact, this was part of the reason behind the Great Recession. Many homeowners tried to take advantage of rising home values by getting larger mortgages, which they were no longer able to cover. This then caused homeowners to default on their mortgages, which flooded the market with a bunch of inexpensive foreclosures. In turn, home values plummeted and many Americans found themselves underwater. However, what happened last year is nothing like what happened in 2008.
Why the Increase in Cash-Out Financing is a Positive Sign for the Housing Market
There are huge differences between today’s housing market and the one leading up to the crash of 2008. These differences mean that nobody should fear a real estate crash is imminent. In fact, today’s real estate market is very healthy and has a lot more room for growth.
First, the mortgage products people are jumping into are quite different from the runup to 2008. The red hot housing market has been fueled by historically low mortgage rates. These low rates mean that it makes more sense for homeowners and homebuyers to get fixed rate mortgage products. In the runup to 2008, many homeowners and homebuyers were going into adjusted rate mortgages. This means that as rates increased, so did the mortgage rates of their loans. This put homeowners in a tough position of having larger mortgages, as well as larger monthly payments. Fixed rate mortgages mean that even if a homeowners did do a cash-out refinance, their mortgage payments do not increase along with rates. In fact, many homeowners who did cash-out refinance mortgages in the past year have lower monthly payments than before. This makes it much less likely they will default on their mortgages.
Second, homeowners have a lot more equity than they did before the great market crash. The real estate market has been governed by the competing forces of supply and demand. Demand for houses has been sky high while the available inventory of homes has been incredibly limited and unable to satisfy all of the potential home buyers. High demand and low supply has led to a market where home values have skyrocketed. Homeowners gained about $1.5 trillion in equity over the past year. A vast majority of these cash-out refinances only cashed out tappable equity. Tappable equity is the amount of equity you have minus 20%. Leaving 20% of your equity intact allows for market fluctuations. Since equity is the difference between the total cost of your loan and the value of your house, equity can change with changes in home values. Leaving 20% protects you from a downturn.
Third, Americans are still cashing out less equity than they were in 2006. In 2006, Americans cashed out about $321 billion in equity as opposed to last year, which was about $153 billion. In 2006, 7% of the equity that was cashed out was tappable equity. However, in 2020, only 2$ of that equity was tappable equity. This makes it far less likely that even if home values decline that millions of Americans will be underwater on their mortgages. It was the sheer number of Americans that owed more on their mortgages than their houses were worth that led to the market crash.
Finally, far fewer mortgage refinances in 2020 were cash-out refinances than in 2006. According to the Freddie Mac data that was discussed earlier, only 33% of refinances in the past year were cash-out refinances. In 2006, that number was an eye-popping 89%. Far more Americans merely refinanced for the same amount or less and are trying to preserve the equity they have gained. This is an understandable approach given that equity is an asset and growing your equity grows the wealth of you and future generations.
Final Thoughts
Today’s data regarding the number of cash-out finances is more of an indication that the real estate market is healthy than that a crash is imminent. Americans are flush with equity and are tapping into it for a number of reasons. Some are using it to remodel and update their current homes. Others are using it to float themselves through the economic uncertainty of the pandemic. The good news is that homeowners have so much equity that even after cashing out some of it, they still have a lot more.
All of this is to say that it is a great time to be a homeowner. Buying a house is a cornerstone of building wealth that lasts for future generations. The great news is that mortgage rates are still at tremendous lows, which means you can still buy a home and take advantage of this market. Demand is not going anywhere and supply is still limited, so home values should continue to increase throughout 2021. The only thing that today’s cash-out refinance numbers indicate is that Americans are taking advantage of the wealth they have generated.
Remember, it is not too late to have this for yourself! If you want to buy a home and build equity for yourself, contact us! We can give you a complimentary, no-obligation mortgage qualifier to see how close you are to having a home of your own. If you are an existing homeowner and you are interested in tapping into the equity you have gained, contact us! We can talk to you about whether or not refinancing makes sense for you and your current situation.
