Over the past 10 years, as interest rates had continuously declined to record low levels, there was a refinance boom in the mortgage market, whereby homeowners were able to continually refinance their existing mortgage with a new mortgage at a lower interest rate. This accounted for considerable volume in the mortgage market.
What is a cash-out refi?
A cash out refinance is a type of mortgage refinance whereby the homeowner takes out some of the equity in their home while simultaneously taking out a new mortgage at a lower interest rate. This is different than taking out a HELOAN or HELOC as there isn’t a second monthly mortgage payment to make. Instead, your old mortgage is replaced with a new mortgage; you borrow more than you owe and pocket the difference.
For example, let’s say you took out a mortgage for $300,000 to buy a home (assume no money down for this example) and, after a few years of making payments the mortgage balance was reduced to $200,000. Your mortgage balance is $200,000 and you have $100,000 in equity. Let’s say that when you took out your initial mortgage, the interest rate on your 30-year mortgage was 5% and today you can refinance at 4%.
Your initial monthly mortgage payments on a $300,000 mortgage balance equaled $1,610.46. Now, your mortgage balance is $200,000, rates are 4%, and you have $100,000 in equity. Let’s say you want take out $50,000 of your home equity in cash while also lowering the rate on your mortgage. You could do a cash-out refinance, whereby you get $50,000 in cash and take out a new mortgage for $250,000.
The new mortgage of $250,000 has a 4% interest rate which equates to a monthly payment of $1,193.54. So, with the cash-out refi, the homeowner received $50,000 in cash taken from the equity they had built-up and reduced their monthly mortgage payment considerably due to the lower interest rate on their new mortgage.
Data on mortgage refinances
Cash-out refinances became extremely popular from 2008 – 2021 as interest rates declined and home values rose (which increased home values). As shown below, refinances became extremely common over the past several years as homeowners looked to lock in low rates.
In fact, the volume of refinance mortgages overtook the volume of purchase mortgages in the last couple years before refinance volume started falling rapidly. This is shown below:
Outlook for mortgage refinances
The reason for the precipitous drop in refinance volume in 2022 is due to the rising interest rate environment which we believe will significantly limit refinance demand for the foreseeable future. When interest rates rise, there is no incentive for a homeowner to refinance as they want to keep their low interest rates locked in place.
Since the start of 2022, the average interest rate on a 30-year mortgage has climbed dramatically, increasing from 3.2% in January 2022 to 6.31% in December 2022!
Because cash-out refinances are no longer beneficial for homeowners, we expect a rise in home loans (HELOANs and HELOCs), as they are now the best way for homeowners to tap into the significant equity in their homes. Despite the rise in interest rates over the past year, home equity values remain elevated, with the average homeowner having over $150,000 in tappable equity in their homes.
In the next blog post, we will discuss the landscape of home equity across the U.S. and how homeowners are utilizing their equity to generate wealth or pay for expenses.
