A danger of rapidly increasing home vaules...the cashout refi

52 Replies

Something occurred to me today as my neighbor just sold his home for 200k more than he paid for it 18 months ago... beware of the cashout refinance.  It is different this time.  It always is.  It is hard to recognize the danger signs when your in it and the FOMO is bubbling over.  The wealth effect of rapid appreciation may show up as overzealous cash outs.  I am thrilled for my neighbor and people selling into the strength of this lava hot housing market. It also bodes well for my own families net worth, but the temptation to realize some gains can be dangerous if this extreme supply shortage driven by the pandemic is short lived.  Just imagine if the average homeowner grabs some equity, they spend it like most consumers on a boat/RV or a new car or a pandemic ending celebration vacation and then interest rates rise, the hotair comes out of the housing market, prices contract and you can imagine the results if we do have an economic slowdown.  As real estate investors we are wise to always be assesing risk and anticipating dangers to our portfolios and the economies we operate in. Keep an eye on cash out refis and heloc utilization rates.  Would love to hear other investors thoughts on this.

The interest rates have already been guaranteed until 2025 by the fed. I am loving this Florida market, nothing has been as hot as this. $25B market right now compared to Texas at $2B. Get your yacht while you can brotha.... party on!

@Mike Terry

Ideally the cash out is used for the next investment not the yacht.

And ideally the rents justify the higher debt service. So as long as the place stays rented you are ok. Just don’t sell.

And ideally the refi is a 30 year fixed. So rates rising later won’t matter.

@Max T. Thanks Max, my concern lies with this area of the greater economy and the resultant impact on the overall housing market rather than my own individual circumstances. Many economic crises are born out of excess and we are seeing signs of that. I just know that there are going to be unintended consequences of our current artificial low interest rate environment and musing out loud about possible impacts and danger signs.

Originally posted by @Mike Terry :

Something occurred to me today as my neighbor just sold his home for 200k more than he paid for it 18 months ago... beware of the cashout refinance.  It is different this time.  It always is.  It is hard to recognize the danger signs when your in it and the FOMO is bubbling over.  The wealth effect of rapid appreciation may show up as overzealous cash outs.  I am thrilled for my neighbor and people selling into the strength of this lava hot housing market. It also bodes well for my own families net worth, but the temptation to realize some gains can be dangerous if this extreme supply shortage driven by the pandemic is short lived.  Just imagine if the average homeowner grabs some equity, they spend it like most consumers on a boat/RV or a new car or a pandemic ending celebration vacation and then interest rates rise, the hotair comes out of the housing market, prices contract and you can imagine the results if we do have an economic slowdown.  As real estate investors we are wise to always be assesing risk and anticipating dangers to our portfolios and the economies we operate in. Keep an eye on cash out refis and heloc utilization rates.  Would love to hear other investors thoughts on this.

In your example are you talking about variable mortgage or fixed?


 

Well said.  I agree with Max if you are using that to pay off high interest debt (and don't rack it up again) or using it as a down payment for another investment property, it could still be a good move.  you still need to watch your numbers if you buy a property.

While it is wise to proceed with caution any time you're re-leveraging an asset, each situation is unique and all of the variables need to be taken into account.

I'm in the process of pulling cash out of one of my buildings which I have no intent to sell in the foreseeable future. I'm pulling out a healthy chunk of change which I'll be using as down payment on the next property, which I'll be patient in finding a good deal.

Icing on the cake is that, since I bought this property during the blip in rates late in 2018 my payment will actually go down despite pulling the majority of the money I have in the deal out.

The FEDs just got out of a closed door meeting last week and the increase in inflation to 2%+ will be changing the interest rates from where they are at now with a national average of 3.09% to above that current benchmark. They will increase the rates slowly and cautiously while the economy continues to grow this year with the current stability.

Yeah, the cash outs are a big deal for sure, and fundamentally 12-15 years ago people were pulling cash out like crazy to support a flashier life. Right now as it sits 40% of homeowners across American have 0 balance on their home, and 61% of the national average has 50% or more in equity. This is a lot different than 2000-2007 leading up to the challenges of the large downfall of real estate. 

Think that there will those people taking out cash for reason like a boat or other items; however, most people are taking cash out to fix up their home and stay in it longer with all the equity they are already sitting on. That compared to a lot of people moving around in 2000-2007 etc.. 

  

@Michael Plante thanks for contributing. To answer your question either fixed or variable. More concerned about over exuberance resulting in over leverage in an overly optimistic future value projections.

Originally posted by @Mike Terry :

@Michael Plante thanks for contributing. To answer your question either fixed or variable. More concerned about over exuberance resulting in over leverage in an overly optimistic future value projections.

With a few exceptions I wonder if real estate in the last 40 years gone down in value and not come back up above previous highs

I’m not concerned  

Great topic for discussion. Leverage is great and getting a bunch of cash out of your property is nice but there are two important things: What are you doing with the money? and Can you pay your new mortgage? Buying a boat means you won't be able to get that cash back when times are tough. Buying another investment has higher likelihood but no certainty. If you've evaluated the deal and it is good, then refi and go for it. 

Market is hot, this isn't anything new, it's probably going to keep going up. If you do a Cash Out Refi, put it in another investment, don't be the consumer that does a cash out refi or a heloc, increases their housing payment, then buys a boat or car with the additional payments for that. Peel off the equity, put it in another investment, then use the cash flow to increase your lifestyle... if you so choose. I'm in a growth stage so even cash flow just gets compounded back into investments and reserves. 

Just seems like one of the silliest things people can do is sell their house for a bigger one, but their income hasn't increased. I fully believe in the thought that your house is the biggest liability you have. It's a monthly payment that's locking up unusable equity. Sure its appreciating, but you can't do anything until you sell or refinance.

I think the concerns of the author are missing one key ingredient for a massive bubble to burst - there is no exotic debt out there as in the mid-2000's. Also, demographics are driving much of this - millenials are in their prime household formation years as we speak for a few more years. I think this is often times overlooked.

@Mike Terry

IMO Values dropping shouldn’t matter unless you HAVE to sell and/or you’ve committed to a mortgage payment that’s economically callous. As long as I can afford my payment I’ll just ride the wave to the next “7 year cycle.”

@Mike Terry cash out still requires equity in the property, so unless there is a major market correction, people should be able to sell for more than they owe. Cash out refinances are good for the economy. People use that cash to buy goods and services. Sometimes they take cash out to pay off loans or credit cards, then often just run up debt all over again.

For any market, the critical factors in housing demand are population and employment. Florida has been a major winner in population and most of that population brought employment with them. 

@Travis C. Thanks Travis. I miss a lot of key points. That’s why I love the discussions that get some great thoughtful responses and help me format my own thinking. Thank you for contributing.

I would say banks are giving out free money right now. refi'd my current house at 2.5%, I say why not. Didnt do cash out though.

Tread very carefully through these times. 

Side note: Every one buying a house right now in over inflated market. Will be on paper, in the hole. Paid 300k for a house that drops to 225k. On paper you are screwed cant ever sell that til the next boom. But you have a good rental with low interest rate for the next ten years.

Originally posted by @Fred K. :

@Ryan Talmadge

Did the fed sign guarantee low interest rates through 2025 in writing? I genuinely can’t tell if you are being sarcastic or not.

RIGHT! LOL

 

This is a great conversation so thanks for starting it @Mike Terry . My opinion is that there are several key differences between the flurry of refi's now vs during the housing bubble. One is that lenders have significantly tightened up their standards. Whereas before we were seeing refi's based on 100%+ of the home's appraised value, today we're seeing 70% - 80% on the high side which means a sizeable equity stake remaining in the properties and the ability for the homeowner to weather a 20-30% price drop if the market suddenly tanks. So, they're less likely to be underwater or significantly under water in a downturn. Appraisals themselves are much more strict than they were during the bubble. Drive by appraisals were common. Lenders didn't really care too much about the value of the home because they knew they were going to bundle the loan with other sub primes and sell it. A lot of banks got stuck with under water properties which forced short sales. They're not anxious to repeat that so the entire system is more conservative than it was during the bubble. Also, I'm not personally seeing a lot of people doing cash out refi's to buy luxury items and finance vacations. Most people remember 2008 like it was yesterday and either got burned themselves or watched their neighbors or parents get burned from those frivolous decisions. As one previous responder already said, many are using the money to improve their homes and there are many, many, who are using the cash out to fund their next real estate purchase. In my book, that's a much more solid investment than a luxury item. And we're in the middle of the pandemic which has people operating much more cautiously with their money. Another difference is that many people during the housing bubble were getting into adjustable rate mortgages and that bit them hard. I don't believe there's a lot of that going on right now. Finally, here's one other thing to consider - there is a school of thought which I happen to subscribe to - which is the debt itself can be the asset. With interest rates this crazy low and inflation what it is, it makes a lot of sense to take out fixed, long term debt at these rock bottom rates. If you don't use it, your dollar is losing value every day to inflation.

@Mike Terry - am I the only one who is sad the neighbor didn’t wait for 6 more months to get free capital gains? If you made 200k in 18 months and sold you’d only keep like $150-160k vs keeping all 200k if you sold in 24 months (if owner occupied).

I just did a cash out refi on a property I bought in 2009. I moved my loan from 4.375% to 3.25% and I got a huge non taxable payout. My rental still cash flows great. I got $200k for $600 more per month. If I can’t make at least $1500/mo with my 200k, I’m screwing up.

Originally posted by @Natalie Schanne :

@Mike Terry - am I the only one who is sad the neighbor didn’t wait for 6 more months to get free capital gains? If you made 200k in 18 months and sold you’d only keep like $150-160k vs keeping all 200k if you sold in 24 months (if owner occupied).

I just did a cash out refi on a property I bought in 2009. I moved my loan from 4.375% to 3.25% and I got a huge non taxable payout. My rental still cash flows great. I got $200k for $600 more per month. If I can’t make at least $1500/mo with my 200k, I’m screwing up.

Thank you for your comment @natalie schanne.  I asked him the same thing.  I think there is a misconception that you have to pay capital gains if you sell before 2 years, but my understanding is that if you roll into another realestate purchase capital gains does not apply.  I am not an accountant by any means, but he seemed confident that he was ok.  If anyone has more confident information on capital gains on a primary please let us all know.