Be Careful Before Turning Your Home’s Equity into Cash

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Here’s a shocker that probably won’t shock you: home prices have risen by an average of 15% nationally in the last year. Not just in hot markets like Austin and Seattle, but everywhere.

If you’ve shopped for real estate or considered moving recently, you’ve probably noticed this already.

Aside from the craziness of the home buying and selling process right now, one other result of this surge in prices has been an equal surge in cash-out refinancings. According to Fannie Mae and Freddie Mac, about $185 billion worth of equity was taken out of American homes in 2020 through this process. Fun fact: That’s the most we’ve seen since 2007, when a similar trend took off right before we plunged into the financial crisis.

That’s one reason why the experts are saying to be careful before tapping your home’s equity for cash, even in this red hot market.

Quote: “In many cases, a cash-out refinance makes sense, allowing a family to cover a medical emergency or a longer-term investment such as college tuition or a home renovation. But cash-out refinances can also carry risks that every homeowner – and every lender – should consider, especially during times of rapid home price increases such as now.” — Sheila Bair, chair of the Fannie Mae Board of Directors and former chair of FDIC.

What is a cash-out refinance?

Let’s start with the nuts and bolts. 

A cash-out refinance is simply a type of home refinancing during which a homeowner refinances their mortgage in order to get or lower interest rate or change their repayment terms while also taking money out of the property in the form of a cash payout. They’re popular in low interest rate environments like we’re experiencing now, as well as in periods of rapid home appreciation.

The appeal is obvious. While you might usually refinance your mortgage to get a lower interest rate, switch from a 30-year loan to a 15-year, cancel out your PMI or otherwise, these days you can still do all those things with the bonus of a big fat check for thousands coming your way too.

What’s the risk of a cash-out refinance?

There really isn’t one, provided you have enough equity in your home and know what you’re getting into. But there are reasons to go in eyes open.

What goes up might still go down: Home prices are rising like crazy now but we all know that won’t last forever. If you refinance and take cash out, be prepared to sit and wait for the market to stabilize around your new home value and don’t freak out if things dip a little.

There are costs involved: A cash-out refinance isn’t free money, and there are closing costs and other fees associated with the process. Be sure to factor those costs into you figures when deciding whether or not to take the plunge. 

Your home is on the line: You already know this as a homeowner, but anything you borrow against the value of your home is secured by … the value of your home. Unlike a credit card, when you default on a home loan, the bank can take your home. And then you’re in real trouble.

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