Rising home prices significantly decreased the number of underwater borrowers and boosted the amount of “tappable” equity that they have in their homes in 2016, according to Black Knight Financial Services’ Mortgage Monitor report.
As of the end of the year, borrowers’ tappable equity had hit $4.7 trillion, according to the report. That’s the highest it has been since 2006.
However, the trend could soon reverse as home prices plateau and as borrowers begin to tap into their equity. The trend may have already begun in the fourth quarter, when 44% of refis were cash-outs – the most equity drawn in eight years, according to the firm’s data.
The approximately $31 billion in equity extracted via cash-out refinances in the fourth quarter was up 8% from the third quarter and up 50% year over year.
Interestingly, the report shows that 68% of tappable equity belongs to borrowers with current interest rates below today’s 30-year interest rate, while 78% belongs to borrowers with credit scores of 720 or higher.
“December 2016 marked 56 consecutive months of annual home price appreciation,” says Ben Graboske, executive vice president of the firm’s data and analytics division. “That served to not only lift an additional 1 million formerly underwater homeowners back into positive equity throughout the year, but also increased the amount of tappable equity available to U.S. mortgage holders by an additional $568 billion.
“There are now 39.5 million homeowners with tappable equity, meaning they have current combined loan-to-value ratios of less than 80 percent,” Graboske adds. “Cash-out refinance data suggests that they have been increasingly tapping that equity, though perhaps more conservatively than homeowners had in the past. In the fourth quarter, $31 billion in equity was extracted from the market via first-lien refinances. While that was the most equity drawn in over eight years, borrowers are still tapping equity at less than a third of the rate they were back in 2005, and they’re doing so more prudently. In fact, the resulting post-cash-out loan-to-value-ratio was 65.6 percent, the lowest on record.
“However, it’s important to remember that we’ve also seen prepayment speeds – which are historically a good indicator of refinance activity – decline by nearly 40 percent since the start of 2017 in the face of today’s higher interest rate environment,” Graboske continues. “Given the fact that nearly 70 percent of tappable equity belongs to borrowers with current interest rates below today’s prevailing 30-year interest rate, the incentive for many of these borrowers is shifting away from tapping equity via a first-lien refinance and instead to home equity lines of credit.”
Graboske says the last time interest rates rose this quickly, the industry saw cash-out refinances decrease by 50% – but rate-term refinances decreased by 75%.
“Based on past behavior, we may see a decline in first-lien cash-out refinance volume, but it’s still likely that cash-out refinances – and purchase loans – will drive the lion’s share of prepayment activity over the coming year in any case,” he says. “That’s why it’s so critical that those in the industry ensure that their prepayment models account for refinancing not just in terms of rate/term incentive, but also equity incentive, as well. Additionally, prepayment models will need a stronger focus on housing turnover as purchase transactions become a larger fraction of total prepayments.”