Is Mortgage Refinancing the Right Move in an Economic Downturn?

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 single asset¹ – 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.^2,3,4 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.

Cash-out refinancing is a common type of mortgage refinancing.⁵ 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 can be less costly than a personal loan, depending on interest rates and closing costs. Rate-and-term refinancing (no cash-out 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.”^5,6 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.^5,6

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.^2,3,4

Millions of Americans lost jobs suddenly and simultaneously in 2020.⁷ The U.S. Federal Reserve took action to help keep mortgage loans flowing. The Fed bought bundles of loans known as mortgage-backed securities.^8,9,10 But in some cases mortgages and mortgage refinancing became harder to obtain.²

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.¹¹

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. History shows that whether mortgage refinancing is the right move for you can change from day to day.