Prediction: This Will Be the Single Biggest Impact of the Fed's Rate Cuts

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Do you know just how much wealth Americans have in the form of equity in their homes? It might shock you.

According to the latest data, Americans are sitting on an incredible $32.8 trillion in home equity. This is more than double the amount of equity they had in 2017, primarily thanks to the 2021–2022 home price surges. And it's four times as much equity as American homeowners had in 2012.

However, homeowners are often reluctant to tap into it. Not because they don't have big projects to finance or have some other use for the money, but because with higher mortgage rates, it doesn't make good financial sense to take equity out of a home for many people.

There are three main ways homeowners can access their equity: refinancing, obtaining a home equity loan, or using a home equity line of credit (HELOC).

Why are few homeowners using their equity?

Using a cash-out refinance to access equity is typically the easiest and most financially practical option. We saw a massive surge in cash-out refinances in 2020 and 2021, when home values rose rapidly and mortgage rates were near record lows.

However, few homeowners are using cash-out refinancing anymore because of rising mortgage rates. For context, the number of cash-out refinances peaked at almost 730,000 in the fourth quarter of 2021. By the first quarter of 2023, they had fallen to just 44,000. That's a big difference.

To illustrate why, consider this example: Let's say that you bought a home in 2021 for $500,000, and you took out a $400,000 mortgage with a 3% interest rate. This gives you a $1,686 monthly principal and interest payment.

Now, let's say that in 2024, your home is worth $800,000 and you're considering a cash-out refinancing to obtain $100,000 for home renovations. For simplicity, we'll say you take out a new $500,000 mortgage at 6.5% interest and receive a check for $100,000 at closing.

The problem is that doing so would give you a new monthly payment of $3,160. Is it worth nearly doubling your monthly mortgage payment to tap into some of your equity? Probably not.

Home equity loans and HELOCs tend to have significantly higher interest rates than primary mortgages. As of this writing, the average mortgage rate in the United States is about 6.15%, but the average home equity loan rate is 8.46%.

The biggest impact of Fed rate cuts?

To be perfectly clear, I don't foresee sub-4% mortgage rates coming back anytime soon, and I've yet to find a single expert who thinks they will. However, many believe rates will dip well into the 5% range in 2025 as the Fed continues to lower its benchmark rate following its 0.50% rate cut on Sept. 18.

This could make the mathematics of cash-out refinancing, home equity loans, and HELOCs work significantly better for many people. For example, it might not be worth replacing your 4% mortgage rate with 6.5% to tap into your equity. But what if you could get 5.25% or 5%? Or what if you could find a stand-alone home equity loan in the 6% range?

In a nutshell, Fed rate cuts and their downward pressure on mortgage rates could lead to a surge in Americans tapping into their home equity. This could result in trillions of dollars flowing into the economy and could be by far the most significant impact of the falling-rate environment.

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