Higher interest rates are crushing mortgage refinancing volumes, but homeowners are increasingly turning to second loans and are unlikely to slow down soon.
Lenders originated some $100.8 billion in home equity lines of credit, or HELOCs, through the first five months of the year, up nearly 50% from last year, according to a report from the Urban Institute’s Housing Finance Policy Center. Home equity loan originations saw a slightly smaller jump, totaling $38.1 billion through the end of May.
Further increases are likely ahead as higher mortgage rates — which climbed above 5.5% last month — reverse the refinancing boom that resulted from mortgage rates falling sharply earlier in the pandemic.
One driver of the boom was cash-out refis, employed by homeowners who wanted to borrow money for home improvements and other purposes. Using cash-out refis, homeowners essentially tacked whatever they wanted to borrow onto their existing mortgages, refinancing the new balance at a lower rate.
But now that rates have climbed substantially, cash-out refis are “just not economical for most homeowners,” said Karan Kaul, principal research associate at the Urban Institute’s housing finance policy group.
Stil, rising home prices have allowed people to build more equity — and homeowners will continue using it for home repairs and major life events such as paying for their kids’ college education.
“For folks who need to tap their equity, these are the only options they’re going to have going forward,” Kaul said, referring to home equity loans and HELOCs.
Banks have historically been the main sources of HELOCs and home equity loans, and some of them reported higher demand during their second-quarter earnings calls last month. Those banks include Charlotte, North Carolina-based Truist Financial, Seattle-based HomeStreet and San Antonio, Texas-based Cullen/Frost Bankers.
Cullen/Frost CEO Phillip Green told analysts that the bank’s HELOC and home equity product pipelines are at “record levels,” according to an S&P Global Market Intelligence transcript. JPMorgan Chase said in May that it was preparing to offer more HELOCs after pulling back on the product in 2020.
But nonbank mortgage lenders — which have been hit by the slowing refinance market and have announced layoffs — are also getting in the mix. Rocket Mortgage announced a new home equity loan product last month, joining competitors such as Guaranteed Rate and loanDepot in rolling out home equity loans or lines of credit.
The entry of nonbanks might make the market more competitive, potentially leading to a slight loosening of underwriting standards on what has typically been a product with very stringent requirements, Kaul said.
About 45% of the HELOCs issued through the end of May went to borrowers with credit scores above 780, according to the Urban Institute’s report. Credit scores on cash-out refis typically do not have to be as high because they are generally backed by the U.S. government or government-sponsored enterprises.
While lenders have often required pristine credit for HELOCs, they will now have “more of an incentive to open up the credit box” to more borrowers who would benefit from them, Kaul said.
For now, banks remain “cautiously optimistic” about the credit quality of HELOCs, given that late payments have stayed subdued, said Ken Flaherty, senior consumer lending market analyst at the consulting firm Curinos. But they are watching for any signs of stress, which could be triggered by inflation, higher interest rates or a possible recession, according to Flaherty.
Despite those concerns, Flaherty said home equity loans should continue to “thrive” because higher mortgage rates are making them a far more attractive option than cash-out refis.
Even if housing prices stall or decelerate, homeowners are still “sitting on a ton of equity” that they built up over the last few years of price gains, he said.
“Those homeowners that are looking to put in that pool or pay for college or just for whatever reason, tap into the equity in their home, they’re coming to the banker and saying: What are my options?” Flaherty said. “And a HELOC makes the most sense, even if it is a higher rate today versus a couple of years ago.”