Dwelling mortgage vs. cash-out refinancing: professionals and cons

Many Americans suddenly have many homes. At least on paper.

Rising home prices have resulted in record levels of home equity. By late last year, around 46 million homeowners held a total of $ 7.3 trillion in equity, the largest amount ever, according to Black Knight, a mortgage technology and research company – an average of about $ 158,000 per homeowner .

This, along with near the lowest mortgage rates, caused a growing number of borrowers to take money out of their homes.

In the first quarter of 2021, the amount of equity paid out rose to $ 49.6 billion – the highest level since 2007, during the last real estate boom. Including the home equity lines of credit, Americans have withdrawn $ 70.4 billion in the past few months alone, according to the latest data from Freddie Mac.

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Although the payout volume is its highest in nearly 15 years, considering how much equity homeowners are sitting on, “the payout amount is pretty modest,” said Len Kiefer, Freddie Mac’s assistant chief economist.

However, it is not always easy to get hold of this money. Since the beginning of the Covid pandemic, the entire industry has tightened access to mortgages and several major banks have stopped offering home equity lines and refinancing to reduce their exposure – or risk – during uncertain economic times.

How a HELOC and a cash-out refinancing differ

Up until last year, a HELOC, a revolving line of credit but with better interest rates than a credit card, was a popular way to borrow against the equity you accumulated in your home.

The average interest rate for this type of loan is 4.86%, according to Bankrate.com. Meanwhile, credit cards are billed at an average of almost 16%.

Some banks still offer this option, although most have at least tightened their standards a little. That means homeowners need to have higher credit scores and lower debt to income ratios.

“In general, the higher your credit rating, the easier it will be to access home equity,” said Tendayi Kapfidze, LendingTree’s chief economist.

There is a better way to free up some of that money, however, he added.

“Because the interest rates are so low, your best option is to refinance through the payout,” said Kapfidze. “The interest rates are lower than the home loan rate and lower than your existing mortgage rate.”

Homeowners may also be able to deduct the interest on the first $ 750,000 on the new mortgage if the withdrawal funds are used for capital improvements (although most households now do not benefit from this write-off as fewer people list).

This works well when mortgage rates are falling because even though you are refinancing your current mortgage and taking out a larger mortgage, you are also lowering your interest payment.

“Significant opportunities remain today as nearly $ 2 trillion in compliant mortgages have the option to refinance and cut their interest rate by at least half a percentage point,” Freddie Mac chief economist Sam Khater said in a recent statement.

“If you haven’t looked at interest rates in the past year, now would be a good time to check this out,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York.

Interest rates below 3% are still available on a 30 year mortgage. “Even those who received fairly low rates are now refinancing at lower rates,” said Boneparth.

Still, borrowers with high credit ratings will get the most favorable terms. “Most people have good credit, but the best rates are those of 740 or more,” added Greg McBride, senior financial analyst at Bankrate.com.

This is not 2005, you can’t get the last of the nickel that you have at home.

Greg McBride

Senior Financial Analyst at Bankrate.com

Of course, there are also some restrictions with cash-out refinancing.

For starters, most lenders require that you keep at least 20% equity in your home, if not more, as a buffer in case house prices fall.

“This isn’t 2005, you can’t get out every last nickel you have at home,” added McBride.

In addition, refinancing via payoff often means extending your repayment deadline, which can put a strain on your monthly budget in the long run, along with the need to prepay closing costs.

As a rule of thumb, “If you can cut your rate by one-half to three-quarters of a percentage point, it’s worth taking a look,” said McBride. “That’s usually the turning point.”

Then “you can recoup your costs in a year and a half,” he said, and “the refinance will be very compelling.”

Finally, refinancing options may be short-lived. Mortgage rates won’t stay low forever, especially as inflation is ticking higher.

“This should add some urgency to refinance sooner rather than later,” said McBride. “The economy is heating up – these are the conditions that lead to higher mortgage rates.”

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