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Why a cash-out refinance can still be a good idea, even as rates rise

Tapping a home’s equity can be a good way for homeowners to consolidate higher-interest debt or fund expensive projects like home repairs.  (Tribune News Service)
Tapping a home’s equity can be a good way for homeowners to consolidate higher-interest debt or fund expensive projects like home repairs. (Tribune News Service)
By Zach Wichter

Economic uncertainty abounds right now as inflation surges and the interest rates on all kinds of financial products rise.

Even so, homeowners may find that tapping their home equity through a cash-out refinance is a financially sound decision, despite the fact that doing so is costlier than it would have been a year ago – or even two months ago.

Here’s why a cash-out refi can still make sense, even in this economy.

What’s going on with mortgage refinance rates

It’s no secret that mortgage rates have been rising rapidly. At the beginning of 2022, the average interest on a 30-year fixed mortgage for a purchase was below 3.5%. Now, less than six months later, that average has shot up about two full percentage points, hovering around 5.5%. While refinance rates are a bit lower than those purchase rates, they’ve followed a similar rising trend.

“It’s a huge increase,” said Joel Kan, associate vice president of economic and industry forecasting at the Mortgage Bankers Association, or MBA, adding that it’s led many homeowners to back away from refinancing.

“Refinances are down 70% year-over-year,” Kan said. “Coming off of two record refi years, 2020 and 2021, where people got a fixed rate below 3.5 percent, there isn’t really a benefit to refinancing.”

He added that mortgage rates should settle to an average of 5% for 2022, based on current MBA analyses. Even at those higher levels, plenty of homeowners could take advantage of a cheaper mortgage.

“There are still millions of consumers that are in mortgage products where they can lower their interest rates by refinancing,” said Joe Mellman, senior vice president of the mortgage business at TransUnion, though he acknowledges that number is much smaller than it was during the refinancing wave of 2020 and 2021.

“While that 5% from a long-term historical perspective is still quite low, it’s significant because it’s up to 60% higher than the rates consumers have locked into in their refinance” if they undertook one in the past few years, Mellman said.

Why homeowners could still benefit from a cash-out refinance

For most homeowners, a rate-and-term refinance doesn’t make sense given the current rate environment, but cash-out refis can still be a great option for many.

Tapping your home’s equity can be a good way to consolidate higher-interest debt or fund projects like home repairs.

“Home improvement is another major use of home equity, as many more consumers are working from home, having a renewed interest in investing in their home,” Mellman said. “Home equity is one of the cheapest ways to finance that home improvement.”

Because home prices have been shooting up the past few years, homeowners are sitting on record levels of equity: an aggregate of $20 trillion in tappable equity currently, TransUnion estimates.

“Especially with inflation on a tear, that means that consumers are putting more on credit cards and they’re putting more on personal loans, which are absolutely standard things that we see when inflation goes up,” said Mellman, adding that taking advantage of all that equity in reserve can make some of those stopgap financing tactics more affordable.

However, Kan says it’s important for homeowners to really run the numbers before drawing down their equity.

“There’s a lot of financial gymnastics,” Kan said. “For some people, getting a cash-out is certainly a better choice than financing it through a credit card or some other means, but they have to be able to stay current and qualify for that mortgage.”

Alternatives to cash-out refis

Especially with mortgage rates trending upward, homeowners looking to tap their equity may want to consider other options, like home equity lines of credit, known as HELOCs, or home equity loans.

“For a cash-out refi, you’re not just refinancing the cash-out portion but you’re refinancing all the existing debt,” Mellman said. “I’d be very cautious about raising your rate on the primary mortgage just to get a lower rate” on your equity.

HELOCs and home equity loans allow you to keep your primary mortgage in place – so if you have a pandemic-era 3% interest rate, you can tap your equity without raising the monthly payment on that initial loan.

But, HELOCs and home equity loans have some drawbacks, too.

HELOCs, for example, allow you to draw on your equity as you need it, but often have variable interest rates, so your monthly payments can be unpredictable. Home equity loans, on the other hand, are a lump sum payment separate from your primary mortgage, which can add an extra layer of complexity to your monthly budget.

“Consumers need to weigh a couple things: whether they need a large chunk of money immediately, or they would like a rainy day fund to draw on over a period of time,” Mellman said.

No matter what equity option you choose, Kan added, it’s important to budget for it ahead of time and be sure you can afford the new payments.

Bottom line

Even as interest rates rise across the board, home equity products remain a relatively low-cost form of financing. Undertaking a cash-out refinance or opening a HELOC or home equity loan can be far cheaper than financing a big project or purchase on a credit card or using a personal loan. Because home equity products use your house as collateral, they tend to have lower interest rates than other forms of financing, but come with a bigger risk if you can’t make the payments.

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