The Future Of The Cash-Out Refinance Market

Education needed for clients on benefits of HELOCs

Insider

Denny Ceizyk

Higher rates threaten to slam the brakes on what was a booming market for cash-out refinances, a popular way to tap into home equity as property values rise. Mortgage industry experts expect the refinance market to continue to slow down, with more people turning to other types of loans to meet their financial needs.

Those higher rates have begun to reverse a major refinancing boom. For two years, two major trends had shaped the mortgage market: rock-bottom interest rates and booming home values. Over the course of 2020, the average rate on a 30-year fixed-rate mortgage hit record lows again and again — driving millions of Americans to refinance their mortgages and save money on their monthly payments. Those rates stayed low throughout 2021, as well, and mortgage refinancing continued to be popular.

At the same time, home values soared across the nation with extremely few houses on the market for sale. In the first quarter of 2022, the median sales price of a single-family home in the U.S. was up more than 16% from the same period the year before, according to the National Association of Realtors (NAR).

Those two trends combined to make last year a particularly busy year for cash-out refinances. People looking to tap their home equity had plenty to borrow, and low interest rates meant they could save money, to boot. In fact, with $248 billion in equity taken out of U.S. homes, 2021 represented the highest volume in 15 years, according to data from Freddie Mac. More than 40% of all refinances involved taking cash-out, and the average amount taken out exceeded $60,000.

With interest rates spiking, the mortgage market is changing rapidly. Refinances have plummeted, down nearly 70% from a year ago, according to data from Fannie Mae.

“Virtually all types of refinancing, including cash-out, have become less popular as interest rates have risen,” says Jacob Channel, senior economic analyst at LendingTree. “Despite the fact that Americans are sitting on record amounts of home equity that would otherwise make cash-out refinancing more appealing, today’s high rates have dampened people’s appetite for refinancing, cash-out or otherwise.”

More may turn to home equity loans

Though interest rates are higher, home equity remains high and homeowners are likely to still want to access this equity to meet their expenses. Through the first quarter of 2022, overall home equity in the U.S. increased more than $3.8 trillion from the year before, a rise of 32.2%, according to data from CoreLogic. That amounts to an average of $64,000 in additional equity for each homeowner — new wealth ready to be tapped.

Rather than replace their primary mortgage with a new, higher-rate one to access this cash, more families may choose a home equity line of credit (HELOC) as an alternative to a cash-out refinance.

HELOCs generally have adjustable rates, meaning they can change over time. Adjustable rates often begin lower than the fixed interest rate at that time, making them a more attractive option with today’s higher rates. If people expect interest rates to fall again in the future, a variable rate HELOC could also be a good option.

Already, homeowners appear to be moving in that direction. Beginning in April, the total volume of home equity loans issued by U.S. commercial banks began to rise after years of a slow, steady decline, according to data from the Federal Reserve. Between May and June, home equity line balances grew by more than $2 billion, reaching $249 billion. The Federal Reserve also noted in late May that lenders are reporting more interest in HELOCs.

A possible recession could change the mortgage industry yet again.

“It’s likely that equity will continue to grow through the rest of 2022, although home price increases should moderate as the year goes on.”

– Rick Sharga, EVP, ATTOM

Economists have warned that a recession could be on the horizon, which could shift the mortgage industry once again. A recession may slow the rise of home values, limiting home equity and reducing the number of cash-out refinances.

“Furthermore,” adds Channel, “lenders will probably be less willing to issue home equity loans if the economy enters a recession, as they’ll want to avoid taking on extra risk.”

Even without a recession, inflation and other economic forces could have the same effect.

“It’s likely that equity will continue to grow through the rest of 2022, although home price increases should moderate as the year goes on,” says Rick Sharga, executive vice president of market intelligence for mortgage data provider ATTOM, in a statement. “Rising interest rates, the highest inflation in 40 years, and the ongoing supply chain disruptions due to the war in Ukraine are likely to weaken demand and slow down home price appreciation.”

Loan officers should work with consumers to consider if cash-out refinance is the right option. Those who recently refinanced may not be good candidates. They may best be pointed to a home equity line of credit.

Also, loan officers should be prepared to run the numbers to discuss the pros and cons of a cash-out refinance versus a home equity line of credit. They should consider the long-term interest costs of a new mortgage versus a credit line to decide what the best option is for their clients.

Loan officers should also be prepared to tell their clients when tapping home equity is not the best choice and suggest alternatives such as personal loans. Despite the higher interest rates, personal loans may provide needed funds for homeowners that do not have enough equity to benefit from a cash-out refinance, HELOC or home equity loan.