By Karen Lynch | American Express Credit Intel Freelance Contributor
5 Min Read | July 31, 2020 in Money
Mortgage refinancing can help you raise cash in uncertain times.
Interest rates tend to drop during downturns as the government generally lowers rates to stimulate economic growth.
But rates can rise and fall suddenly, and loan requirements may tighten, as lenders react to changing market risks.
Economic downturns have been known to change the rules of the game in personal finance – and that includes mortgage refinancing.
Your reasons for refinancing may seem straightforward. Let’s say you have a pressing financial need and are looking to take advantage of your home – most Americans’ biggest asset – to raise cash. A “cash-out refinancing” is a pretty common way to do this, in normal times. So why not in hard times?
Mortgage refinancing can get tricky during an economic downturn, as happened during the 2008 financial crisis and in early 2020.1 Government mandates and market forces sometimes trigger sudden swerves in the way lenders usually work. Interest rates can change in unexpected directions. Borrowers can suddenly face new requirements. Real estate pricing may turn into a guessing game. At the same time, your own financial circumstances could become uncertain.
In short, there’s no simple answer as to whether mortgage refinancing is the right move in an economic downturn.
Most mortgage refinancing is cash-out refinancing. This works by replacing your existing mortgage with a new one, at an amount higher than what you still owe on your home, leaving you with extra cash to use for other purposes. Paying back that extra cash as part of a mortgage is usually less costly than a personal loan. Rate-and-term refinancing, on the other hand, is used to lower the cost of your current mortgage when interest rates are favorable, without taking any “cash out.” In either case, your home acts as collateral, which introduces at least some risk of losing the roof over your head if you don’t repay the loan.
Homeowners do cash-out refinancing for various reasons, like home renovation and debt consolidation – and, in hard times, to shore up their finances. Lenders will usually charge a bit more for cash-out refinancing than for rate-and-term refinancing, but it’s usually still less than other types of credit. Mortgage refinancing interest rates have been in historically low territory lately, averaging around 3-4%.2
Economic downturns, though, have potential to disrupt “business as usual” in mortgage refinancing. That’s what happened during the 2008 financial crisis and again in early 2020, which is an instructive example.
Millions of Americans lost jobs suddenly and simultaneously in 2020. The U.S. Federal Reserve took action to help keep mortgage loans flowing. It began to let banks lend to each other for a little over 0%, so they could pass on historically low rates to customers. The Fed also bought bundles of loans known as mortgage-backed securities, expecting that the banks selling those securities on the financial market would use the proceeds to keep lending rates low.
But bankers didn’t always act as expected. Mortgage interest rates became surprisingly volatile, not tracking the rates of U.S. Treasury Bonds like they usually do, and mortgages and mortgage refinancing became harder to obtain.
Why? For one thing, lenders worried about the risk of defaults on loan payments. Uncertainty about the economy and the way government funds were flowing also disrupted the market on which mortgages are bundled and resold as securities. High numbers of refinancing applications were creating backlogs. A government relief program added to the workload at some mortgage companies by causing a surge in applications for forbearance – a form of relief that allows people to defer monthly mortgage payments without facing fines, foreclosure, damaged credit scores, or other harm to their pocketbooks.
Some lenders tapped the brakes, actually increasing interest rates or tightening requirements such as higher credit scores. Processing loans often took longer, including demands for more proof of borrowers’ ability to pay. Some lenders discontinued certain types of mortgages. Others stopped offering home equity lines of credit, which are often considered an alternative to cash-out refinancing.3
Because of these factors, and sudden increases and declines in interest rates, the number of Americans likely to both qualify for, and benefit from, mortgage refinancing began to seesaw. It went from 14.3 million at the start of March 2020 down to 3.3 million by the middle of the month and back up to 10 million toward the end of the month, according to the Mortgage Monitor.4 And that interest rate volatility has continued. This example shows that whether mortgage refinancing is the right move for you can change from day to day.
Still, “families look to their largest source of wealth, their home equity nest egg, to buffer massive and unforeseen economic shocks,” according to a report from the Brookings Institution.5 And the Mortgage Bankers Association anticipates that more homeowners will be refinancing throughout 2020 despite volatility in interest rates, because those rates keep falling back to historically low levels.6
But when refinancing during an economic downturn, personal finance advisors suggest extra diligence. Watching for market changes and shopping around becomes even more important when interest rates may swing from day to day and from lender to lender. You’ll need more patience when processing loans takes longer.
It’s worthwhile to check and recheck your own financial profile and other pertinent information against lenders’ changing requirements to qualify for a loan. The same goes for making a realistic assessment of your financial stability. Wharton School Finance Professor Nikolai Roussanov put it this way: “Think about what’s going to happen maybe five or 10 years down the road, to whatever might happen to your income, to your employment prospects. Those debts that you rack up now will be there for you to repay.”7
Homeowners with less robust financial profiles may have fewer options, as lenders tighten requirements when economies turn down. But those homeowners may at least hold onto some of their cash a little longer thanks to government relief measures, such as the various 2020 forbearance programs.8
During an economic downturn, many people look to raise the money they need by refinancing their mortgages. The roof over your head provides domestic shelter, of course, and at the same time it can be a useful tool to help you weather financial headwinds. But it’s essential to strike the right balance when deploying such an important asset.
1 “Not Everyone Benefited from Lower Interest Rates During the Great Recession,” Kellogg School of Management
2 “30 Year Mortgage Rate,” YCharts
3 “Wells Fargo Joins Chase in Halting HELOCs,” Housing Wire
5 “The Impact of the Coronavirus on Mortgage Refinancings,” Brookings Institution
7 “What’s the Link Between Mortgage Refinancing and Recessions?,” Wharton School
8 “Learn about mortgage relief options and protections,” Consumer Financial Protection Bureau