The Home Equity 'Piggy Bank' Is Back, But Not the Attitude

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The end of the U.S. housing boom in the mid-2000s was a prime cause of the 2008 recession and the near-collapse of the financial system. In the years that followed the peak, millions of American homeowners struggled as property values fell far below the amount of mortgage debt they owed. Even low interest rates weren't enough to save many mortgage borrowers from defaulting on their loans and ending up in foreclosure (especially those whose financial situations made them poor candidates for refinancing).

Yet as the housing market has slowly and steadily recovered ground over the past several years, many homeowners who were once underwater on their mortgages have found themselves with equity in their homes again -- and they're increasingly looking at tapping that equity, according to a new report from home-finance specialist Freddie Mac.

Coming Full Circle

What crushed homeowners in the aftermath of the housing bubble was the realization that home prices could fall for a sustained period. Combined with the aftereffects of years of questionable mortgage practices that had encouraged many borrowers to take on more debt that they could afford, the impact of the housing bust cascaded throughout the financial system, bringing several large banks to the brink of collapse.

But the recovery in home prices has finally sent home equity levels in a positive direction. According to the Federal Reserve, home equity has grown by about $3 trillion between mid-2012 and mid-2014, thanks in large part to an almost 17 percent climb in the price of the typical U.S. home. Among those refinancing during the third quarter of 2014, about half had seen their property values rise since they took out their previous mortgage, a figure which Freddie Mac says is the highest in five years.

One big reason home equity levels rose so much is that most borrowers chose not to use cash-out refinancing strategies. Instead, much of the refinancing focused on trying to capture lower interest rates, either through locking in conventional fixed-mortgage financing or by looking to shorten loan maturity through the greater use of 15-year mortgages and other less-common products. Not only were borrowers not tapping equity as it accumulated, but their use of shorter mortgages made their equity climb faster than it would have under conventional 30-year loans.

Government programs also played a role. The Home Affordable Refinance Program led to rate reductions of about 1.7 percentage points on an average loan, which Freddie Mac says cut payments by about $280 a month on a typical $200,000 mortgage. With many HARP-eligible properties involving underwater mortgages, supporting those who wanted cash-out refinancing wasn't the focus of the program.

Cash-Out Refinancing: Getting Back to Normal?

The latest figures from Freddie Mac, though, show that the trend might be moving back toward cash-out refinancing. During the third quarter, about $8 billion in home equity was cashed out through refinancing transactions, up more than 40 percent from second-quarter levels. The increase was the second straight quarter in which cash-out refinancing volume rose, returning to levels last seen in early 2013.

As large as that percentage of increase sounds, cash-out refinancing remains at extremely low levels. At the peak of the housing boom in the second quarter of 2006, borrowers pulled out $84 billion in cash through such refinancing activity, more than 10 times the most recent rate. Put another way, in 2006, 89 percent of those refinancing their mortgages took advantage of the opportunity to pull out extra cash from their home equity. That compares to just 28 percent last quarter, and even though that figure was the largest since 2009, it's nevertheless at historically low levels.

Another thing that homeowners should understand is that cash-out refinances aren't the only way to tap home equity, and right now, they might not even be the best way for many borrowers. The Freddie Mac study only looked at borrowers refinancing their primary mortgage loans, which is most likely to happen when interest rates are trending downward. With such low mortgage rates prevailing over the past several years, most people who ever planned to refinance their mortgages have already done so and now enjoy rates that they can't easily improve on. For them, the better way to tap into their equity is through a home equity loan or line of credit, which preserves the low rate on their current mortgage and comes with fewer fees like closing costs.

For now, policymakers don't have to worry much about cash-out refinancing helping to inflate a new housing bubble, as homeowners in general haven't yet started treating home equity as a piggy bank again. The uptick might have a minor impact on economic activity, but for it to become troubling from a longer-term perspective, the figures would have to come a lot closer to matching what we saw during the housing boom.

Motley Fool contributor Dan Caplinger is quite happy with his home-financing situation right now. You can follow him on Twitter @DanCaplinger or on Google+. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.
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