The numbers are officially in for the first quarter of 2021, and some surprising financial trends are beginning to take shape. One interesting trend is the number of Americans who are tapping into their home equity through cash out refinances. According to a new report in the Wall Street Journal, the amount of home equity cashed out in the first quarter of this year is an estimated $49.6 billion, up over 80% compared to last year.
Why are so many consumers accessing their home equity through cash out refinances this year?
Why Americans are Getting Cash Out Refinances
There are several reasons why cash out refinances have suddenly gained in popularity, but the two most influential factors are rising home values and record low interest rates. Between 2020 and 2021, the housing market has boomed. Record numbers of people have moved due to the pandemic, and these historic low interest rates have encouraged more consumers to buy. Low inventory and low interest rates have created a seller’s market, with many homes getting ten to fifteen offers above asking within hours of being listed.
But what about people who aren’t moving? Consumers have taken advantage of the same low interest rates, and their increased equity as home prices rise, to access inexpensive cash. Some consumers, frustrated by the difficult market and their inability to find a reasonably-priced larger home, have gotten cash out refinances to add to their existing homes instead.
Three Things You Should Know Before Getting a Cash Out Refinance
With current mortgage rates hovering around 3% for a 30-year fixed rate loan and around 2.4% for a 15-year fixed rate loan, now is certainly a good time to borrow against your home’s equity—if you’re smart about it. Before rushing out and getting your hands on your home equity, be sure you understand the risks as well as the benefits:
- There Could be an Increased Risk of Home Foreclosure:When you get a cash out refinance, you are adding to your debt burden and increasing your monthly payments. Although the financing is cheap (and, in some cases, refinancing at a lower interest rate can partially pay for the equity you’re cashing out), it’s still additional money you’ll have to pay back eventually.
- Don’t Use a Cash Out Refinance to Support Poor Spending Habits: There are wise reasons to get a cash out refinance, such as paying for needed home repairs or home upgrades, paying off a second mortgage at a lower rate, or even investing in the stock market or a new business. There are also financially unwise reasons, such as paying off credit card debt. In general, you should never use your home to secure debts that were previously unsecured. Even if it seems like a good idea to trade high credit card rates for low mortgage rates, it could land you in a lot of hot water if you don’t fix your spending habits first. You’re better off seeking credit counseling and consolidating your credit card debt instead.
- A Cash Out Refinance is Different Than a HELOC:Though people sometimes use the terms interchangeably, a cash out refinance is a lump sum loan while a HELOC functions more like a revolving credit line where you use the money only as needed and pay back only what you use. There are benefits and drawbacks to both. One of the main drawbacks of HELOCs is the new IRS rules that make HELOC interest tax-deductible only when the money is used for home improvements.
If you remain aware of the potential pitfalls and get favorable terms and low closing costs from your lender, now is a great time to access your home’s equity.
