In previous columns we have mentioned that, despite rising interest rates over the last year, there have been a few silver linings for current homeowners. One of those is silver linings is that home values have continued to rise. Now, we are not seeing the meteoric rise in values like we saw in 2020 and 2021, where some areas experienced 30% increases to property values, but they have steadily continued to rise. Many economists predict that this trend will continue through this year as well.
With rising home values comes increased equity for the homeowner. Equity is simply the difference in the value of the property and the amount owed on it. For example, if a person owns a home worth $300,000 and they owe $175,000, then that means they have $125,000 worth of equity in their home.
A way that people can utilize that equity is through a cash out refinance. Many borrowers do a cash out refinance to pay off existing high interest debt or to do some renovations and remodeling. There are many reasons that pulling equity out of your home can make good financial sense.
However, if this is something you are considering, the time to act may be sooner than later. Why? Well, in most cases, a cash out refinance (especially where the homeowner is borrowing more than 70% of the value of the home) is going to carry a slightly higher interest rate than a purchase transaction or a rate term refinance (where you are just paying off a first mortgage only). This is due to something on conventional loans called Loan Level Price Adjustments (LLPAs). To put it very simply, a LLPA is a “bump” in the pricing of the rate due to the risk associated with the loan. (Cash out refinances are viewed as a bit more risky than some other types of loans.) These “bumps” result in an increase in the mortgage rate on these types of transactions.
So why act sooner than later? Because starting on May 1, Fannie Mae and Freddie Mac (the two largest purchasers of Conventional loans on the secondary market) are increasing these Cash Out LLPAs based on credit scores, loan to value, and other factors. In layman’s terms, after May 1, the rate and cost to obtain a cash out refinance will be substantially higher than it is now.
It is also worth noting that if someone did a cash out refinance now and mortgage rates drop later in the year (which many are predicting that they will), the borrower could refinance again at a much lower rate without all of the LLPAs of a cash out, because they would only be paying of a first mortgage at that time. In other words, they could refinance now to pull the equity out and possibly refinance at a later time to drastically reduce their rate and monthly payment.
Over the last year, we have seen a dramatic increase in rates (although the last few weeks have given us a bit of a breather). Even so, if you are in a situation where you are considering pulling equity out of your home, it may be beneficial to do so now, rather than waiting. Contact a local mortgage professional to see what options are available to you.
Josh Moody has decades of experience in residential mortgage lending and is with The Mortgage Center in Cullman, Alabama. He resides in Gardendale and is a contributor to North Jefferson Magazine.
