Here’s a strange mortgage question: Why are borrowers trading in cheap mortgages for more expensive financing?
If you had a mortgage in the 2% range — or 3% or 4% — would you trade it for a 6% rate? It doesn’t seem like an attractive exchange, and most homeowners with low-rate financing have been holding onto their loans with great ferocity.
The catch is that many owners also want to get cash from their properties. This is possible for millions of homeowners because of the huge price increases seen during the past few years.
In fact, home values have grown more than 47% since 2021, according to the Harvard Joint Center for Housing Studies.
In basic terms, there are two ways for homeowners to access their new equity. They can sell or refinance.
Selling To Access Equity
Selling is not a likely option. Most owners are holding on to their low-rate mortgages and not going anywhere.
Existing home sales are in the ditch, down 5.4% in June from a year earlier according to the National Association of Realtors (NAR). In fact, at this writing, it looks like existing sales will be below four million units for all of 2024, a very low number.
But some owners do want to sell. Things happen. People want to move for many reasons, perhaps to get a new job, to be near family, as a result of divorce, or to live in an area with lower overall costs.
As a result of such change, the lofty market share held by low-rate mortgages declines every year. ICE Mortgage Technology, in its July ICE Mortgage Monitor report, said that “As of May, 24% of mortgage holders had a current interest rate at or above 5%, up from 10% two years ago.”
“All in,” added the ICE report, “there are 5.8 million fewer mortgages with rates below 5% than there were two years ago, and 4.8 million fewer with rates below 4%, as borrowers with lower rates slowly sell their homes or, to a smaller degree, refinance to withdraw equity.”
In other words, the stockpile of low-rate mortgages erodes as people move.
Owners who want to sell are likely to find a receptive market. According to NAR, in the second quarter, single-family existing-home sales prices rose in 199 of 223 metro areas and fell in 22.
Overall, the typical single-family existing home saw a 4.9% price increase from a year ago.
Refinancing to Free Equity
While selling is one way to access home equity and perhaps a six-figure check at closing, moving is not for everyone. Selling means ending today’s bargain mortgage and – in many cases – financing a replacement property at a higher rate.
However, for those with low-rate first mortgages and lots of equity, there are still opportunities to pull cash from their properties while leaving existing loans in place.
It’s possible to simply replace an existing mortgage with a current rate, but that doesn’t make much sense given that today’s rates are higher than the interest levels from a few years ago. A better option for many owners is to keep the current financing in place and get a second mortgage.
Basically, a second mortgage is exactly what it sounds like. The existing first mortgage stays in place with its original rate and terms while the property gets an additional mortgage to free up equity.
The owner gets cash when the second loan closes.
The new second mortgage reflects today’s mortgage rates, however, those new rates only apply to a portion of the homeowner’s total debt. If you think of the mortgage rates for the combined first and second mortgage, they are likely to have a blended interest level that’s significantly below today’s quoted rates for new financing.
An alternative refinancing option that keeps the current first loan in place is a home equity line of credit (HELOC).
A HELOC is similar to a credit card because it has a line of credit. In the first phase – the loan’s draw period, maybe ten or 15 years — you can borrow and repay from the line of credit in much the same way you would with a credit card.
In the second period – the repayment phase — perhaps another ten or 15 years, any balance from the first phase is repaid like a regular mortgage with monthly payments. But, rather than a second phase, some borrowers may prefer to pay off any remaining debt from the draw period or to get a different loan if better terms are available.
The attraction of a HELOC is that the existing first mortgage stays in place with its original rates and terms. Homeowners can then use as little or as much of the HELOC as is needed while the low-rate first mortgage remains unchanged.