If you are refinancing this year, the odds are good that you are also tapping your home equity -- "cashing out" additional money for investment, large consumer purchases or for other purposes.
And you are probably paying at least a slightly higher interest rate on the new mortgage compared with the old -- a complete reversal of the traditional reason for refinancing, lowering the interest rate.
Those are some of the findings of the latest "Cash-Out Refi" study conducted by mortgage giant Freddie Mac. In the second quarter of 2007, according to the study, more than four out of five refinancers -- 83 percent -- took out replacement loans that were at least 5 percent larger than the original.
A cash-out works like this: Say you have a $200,000 first mortgage on a home appraised for $400,000. In order to pay for college tuition expenses and a major kitchen rehab, you decide to pull out $50,000 of your $200,000 net equity.
You refinance into a new $250,000 first mortgage. Although the new loan comes with a higher interest rate than the previous, and monthly payments are higher, the deal makes financial sense for you because (1) you've now got $50,000 cash to pay your bills, and (2) the interest rate on the new $50,000 of debt is lower than it would be if you took out a home equity credit line or loan.
According to Freddie Mac chief economist Frank Nothaft, $76.7 billion of equity withdrawals were pumped into the economy through cash out refis during the April-May-June period. The 83 percent rate for cash-outs is near the upper end of the historical scale: As recently as the second quarter of 2003, for example, just 33 percent of refinancings involved equity withdrawals.
By mid 2004, as the housing boom began raising equity holdings rapidly, the cash-out ratio jumped to 43 percent. It then rose steadily, quarter by quarter, into 2006, when it hit its all-time peak of 88 percent. The ratio has backed off slightly since then, according to Freddie Mac, as equity growth has slowed.
Equity withdrawals are likely to drop even further in the coming months, said Amy Crews Cutts, deputy chief economist. "Because the refinance share of mortgage originations is expected to decline by as many as 10 percentage points in the second half … we expect the volume of cash out activity to decline by roughly a third later this year."
However, she added, "Overall there remains a large amount of equity in homes that owners can tap if they wish"-at least as long as rates remain relatively favorable. The latest Federal Reserve estimates put homeowner net equity at around $11 trillion, giving Americans a giant asset to convert to spendable money should they need to.
The latest study also found that the median ratio of homeowners' new, post-refi interest rates on their new loans was higher than their previous loan rate by about one-eighth of a percentage point.