Combine equity-rich homes with a bunch of microbes and now may be the best time for cash-out refinancing since 2012, the year weekly mortgage rates hit 3.31%.
According to ATTOM Data Solutions, the term “equity rich” means that a home’s mortgage balance is not more than 50% of the property’s estimated market value. The company says at the end of 2019 there were 14.5 million equity-rich homes, about one of every four houses with a mortgage.
How did residential balance sheets become so flush? And why is now such a good time for a cash-out refinance? You may be surprised by the answers.
Microbes and mortgage rates
We don’t know where mortgage rates for cash out refinancing will be in the future but we know with certainty where they are today. Mortgage rates are low, very low. Freddie Mac has tracked weekly mortgage rates for decades. See Freddie Mac vs Fannie Mae. Between early 1971 and the end of 2019 weekly mortgage rates averaged 8.0% (7.999%). Mortgage rates as this is written are less than half the long-term norm.
The reason for low rates is that the world has a lot of cash and – surprisingly – not a lot of demand. Bloomberg reported last August that there’s some $15 trillion invested worldwide with negative interest rates. In some cases mortgage borrowers overseas are getting checks from their lenders!
Foreign money is being sent here as investors search for better returns. That’s part of the reason for low rates. But now, in early 2020, the mortgage market is being pummeled by events in China. The Wuhan coronavirus has slowed economic activity in China and that’s a big deal. According to The New York Times, the virus “has shaken companies and investors around the world.”
“In some economically important regions, such as China and the euro area, data through early this year suggested that growth was steadying,” said the Federal Reserve in early February. It warned that “the recent emergence of the coronavirus, however, could lead to disruptions in China that spill over to the rest of the global economy.”
First identified in January, the fast spread of the Wuhan virus has coincided with a sharp mortgage rate decline. For the week of January 2nd mortgage rates stood at 3.72% for fixed-rate, 30-year financing according to Freddie Mac. By February 13th the same loan was priced at 3.47%. That’s a .25% drop, a visible decline when rates are so low.
Whether the coronavirus effect will continue is unknown. Containment — or development of a vaccine — might quickly reduce disruptions created by the virus. For the moment the virus is with us, mortgage rates are near historic lows, and the reality is that a window of opportunity is open.
Trillions in untapped equity
Most American homeowners – but not all – have an increasingly large amount of real estate equity. Residential real estate was worth $29.2 trillion at the end of the third quarter according to the Federal Reserve. Subtract $10.5 trillion in mortgage debt and you wind up with home equity worth $18.7 trillion.
Homeowners can access this equity with a cash-out refinance. In addition, while refinancing they may be able to lower the interest rate and monthly cost of the mortgage debt they now have in place. There are three basic cash-out refinancing strategies.
- You replace a current loan with a new and bigger mortgage. Example: You have a $100,000 loan at 4.5% and refinance with a $150,000 mortgage at 3.5%.
- The current loan remains in place and you get a second mortgage. Example: Your current financing has a $100,000 balance. You like its rate and payments. You get a $50,000 second mortgage at today’s rates and keep the old loan in place.
- You get a home equity line of credit (HELOC). This is really a second mortgage where you have the right to borrow up to the limit of your credit line. Example: You like your current financing. You leave it in place. You also get a $50,000 HELOC and borrow from it up to the credit limit.
How much cash-out refinancing can you borrow?
How much you can borrow depends in large measure on your property’s existing debt, it’s fair market value, your financial profile, and how much new debt lenders will allow.
Lenders use a loan-to-value (LTV) calculation as one way to limit risk. For instance, the FHA will finance up to 80% of a home’s value with a cash-out refinance. The VA will help qualified vets with 100-percent LTV refinancing. Fannie Mae and Freddie Mac want a 20% equity cushion for a cash-out refinance. Other loan programs – such as “portfolio” loans created by individual lenders – may be available with higher LTVs that allow larger cash-out refinancing.
Cash-out refinancing and cautious borrowers
It might seem as though low rates and gobs of equity should create massive opportunities for lenders. Oddly, that’s not the case. Borrowers aren’t biting, they’re leaving large amounts of equity untouched. The amount of household debt at the end of 2019 was actually lower than in the third quarter of 2008. Homeowners have become financially conservative, they understand that debt needs to be repaid. That’s a good approach to borrowing.
The US loan-to-value (LTV) ratio – the ratio of debt-to-property values nationwide – has fallen substantially. According to the Urban Institute (UI), the LTV for residential real estate is now 35.4% – down from 54.7% in 2009.
UI points out that in the second quarter of 2019 home equity lines of credit – HELOCs – amounted to $399 billion. Back in 2009 the same form of borrowing represented outstanding debt worth $714 billion.
“A declining proportion of homeowners have a mortgage,” said the Urban Institute. “The share of homeowners with a mortgage declined steadily between 2008 and 2017, from 68.4 to 62.9 percent – the lowest level since at least 2005. Conversely, the share of owner-occupied households with no mortgage has climbed to 37.1 percent over the same nine-year period.”
The combination of low rates and reduced lending levels is good news for those who want a cash-out refinance. It means lenders really, really want your business. Why? Because lenders have a lot of fixed costs. More loan volume can help them lower costs per mortgage. Those costs in the third quarter of 2019 amounted to $7,217 per origination according to the Mortgage Bankers Association.
Cash-out refinancing puts billions of dollars into the pockets of American homeowners every year. It’s real money available to property owners at interest rates that are generally below the interest costs for credit cards, auto financing, student loans, personal loans, and business financing. At the same time, cash-out refinancing is just a small portion of the “tappable” equity found in US homes. If you have equity and need funds to pay for a college education, start a new business, or for other purposes you may need to look no further than your front door to find the cash you need.
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