The rise in home value is great news for homeowners looking to tap into the equity of their home to pay down debt or make big purchases, but this causes concern for consumer advocates. They worry that this might be setting the stage for a spike in loan defaults.
Paying off credit card debt and financing long-delayed home-improvement projects are just two reason why consumers might want to tap into their home equity. With rates rising, banks are happy to offer a cash-out refinance option to consumers.
The issue though, is that a cash-out refi is much riskier than a credit card loan is, said Sarah Wolff, a senior researcher at the Center for Responsible Lending.
“You are trading your unsecured debt for debt that’s tied to your home, and a default in that case would be much more catastrophic,” she said.
Banks and lenders are already seeing an increased demand for cash-out refis. The total dollar amount of home equity cashed out rose to $17.6 billion in the third quarter – a 66 percent increase – compared to the same period in 2015.And it appears that the trend is showing few signs of slowing down, said Len Kiefer, deputy chief economist at Freddie Mac.
“We expect overall volume of cash-out refis to trend higher,” Kiefer said.
In November, SoFi and Fannie Mae introduced a cash-out refi option specifically for consumers looking to pay down their student loan debt. However, the overall industry level of cash-out refis remains at an extremely low level, Kiefer said. During the recession, the total value of cash-out refis remained below $10 billion for several years. While the total number value has continued to inch back up, they will remain below the pre-crisis levels of $30 billion and higher, Kiefer said.
A shift in interest rates could also continue to lead to more cash-out refis. The prime rate could continue to rise if the Federal Reserve proceeds with rate hikes, which could make credit card debt more expensive. Consumers might want to use a cash-out refi to pay off those credit cards, Kiefer said.
In the third quarter, the total household debt rose 2.4 percent, to $12.35 trillion, compared to the previous year, according to the Center for Microeconomic Data at the Federal Reserve Bank of New York. A portion of that total, credit cards, also rose – credit card debt rose 4.6 percent to $747 billion in the same period.