Cash-out refinances had a moment in 2021 as home equity soared. Here's how they work and whether they'll remain popular in the 2022.
Rising home prices have made it harder for first-time homebuyers to compete in 2021, but if you bought a home early in the pandemic, or owned one before it, it might feel like you spun triple-7’s on a slot machine and home equity came tumbling out.
In 2021, homeowners tapped into that home equity at the highest rate in 16 years.
According to data analytics company Black Knight, homeowners collectively withdrew $275 billion in home equity via cash-out refinances last year – $80 billion of it in the fourth quarter alone. That’s a 20% increase from the previous year and just shy of records set in the mid-2000’s.
More than a million people pulled cash from their homes in each of the last five quarters as homes appreciated by nearly 20% nationwide in 2021.
What is a cash-out refinance?
With a cash-out refinance, homeowners take out a loan for more than what they currently owe and receive the difference in cash. Why would anyone do this? Because it allows them to tap into the home equity they’ve built over time.
For example, someone that has an existing $150,000 loan balance on their $300,000 home might qualify to take out a loan for $200,000 and get $50,000 in cash, less closing costs.
$200,000 new loan balance - $150,000 old loan balance = $50,000 cash-out less closing costs
The cash can be used for just about anything, but it’s generally recommended to use it for things like investments, making home repairs, or paying off debts rather than vacations and mid-life-crisis cars.
There’s a few reasons why cash-out refinancing became so popular in 2021 and may continue into 2022.
Financing renovations and home repairs
The pandemic sparked a trend of home renovations. Homeowners required more from their homes – home offices, learning areas, recreation space – or simply went stir crazy during lockdowns and remote work. Cash-out refinances are tailor-made to fund home renovations because it uses your home equity to further increase the value of your home.
It’s like a fish eating one of its scales to grow an entirely new fin.
This may become an even more attractive option in 2022. As rising prices and mortgage rates erode affordability, homeowners may be more inclined to renovate their current home using a cash-out refinance rather than enter a brutally competitive market.
Mortgages were really cheap in 2021
Mortgage rates hit record lows in 2021 which made refinancing worthwhile for a very large pool of homeowners. There were simply more people refinancing, and many of them decided to pull out home equity while they were at it.
Although they’re still low by historic standards, rates have been substantially higher in 2022 which may deter some people from refinancing. However, whether a refinance “pencils out” (a fancy mortgage term for being worthwhile) depends on each homeowner's situation.
Homeowners have more equity to tap
Cash-out refis boomed in 2021 because home equity boomed in 2021. According to CoreLogic, homeowners with mortgages collectively gained $3.2 trillion in home equity last year, a 29.3% increase year over year.
Just 1.1 million homeowners have “negative equity,” the lowest share in 12 years. Negative equity, also called being underwater, happens when a borrower owes more on a mortgage than the home is worth.
Equity is calculated by subtracting the mortgage balance from the home’s current value.
So someone that owed $150,000 on a home valued at $300,000 had $150,000 in home equity at the beginning of 2021.
But after a year of 20% home appreciation and regular mortgage payments, they may only owe $130,000 on a home that’s worth $360,000, raising their home equity to $230,000.
That’s an increase of $80,000 in home equity in one year just by making regular mortgage payments and more cheddar to tap into with a cash-out refinance.
With home prices expected to increase throughout 2022, homeowners will continue to increase home equity and the pool of many available in a cash-out refinance.