Is Home Equity a Better Way to Refinance Credit Card Debt?

Average credit card interest rates recently reached an all-time high, according to the Federal Reserve, while mortgage rates are near all-time lows, a trend reinforced by the recent Fed rate cut.

According to Federal Reserve data, the average interest rate for a 30-year fixed rate mortgage, one of the largest categories of secured loans, was 3.56% on September 12, 2019, while the average interest rate for credit card debt, an example of unsecured consumer lending, topped 17% for the first time since the early 1990s, reaching 17.14% in the second quarter of 2019.

That’s a difference of over 13.5%, which makes a dramatic difference in the cost of borrowing.

By comparison, a decade ago in August 2009, the difference between the two rates was only 8.22%.

Despite the record difference in interest rates, U.S. consumers keep piling on credit card debt—credit card debt is currently at the highest level ever recorded by the Federal Reserve—while sitting on a record amount of tappable home equity.

Secured loans are loans that provide the lender recourse to an asset in the case of default. Lending against homes, including mortgages and home equity lines of credit, are perhaps the most well-known types of secured lending, but auto loans, boat loans, or loans for recreational vehicles are other examples. Unsecured loans, on the other hand, do not give the lender recourse to an asset in the case of default. Most credit card debt and personal loans fit into this category.

I was curious to find out if perhaps these were entirely two different groups of consumers: on the one side, homeowners with a lot of home equity and no unsecured debt, and on the other side, renters with a lot of credit card and personal loan debt. Could there really be a lot of people who have access to low interest rates who nonetheless are choosing more expensive debt?

We did a detailed study of all US homes (all without personally identifying information) and results of the study were surprising: we found that there are 16.3 million US homeowners who are borrowing in aggregate over $200 billion at unsecured rates and simultaneously have sufficient home equity to potentially qualify for a secured loan that would allow them to refinance at lower cost.

We calculated that the average homeowner in the study could save over $6,000 by taking advantage of lower rates, which represents over $100 billion in total savings.

Full disclosure: I work for Figure, a home equity lender, but that fact had no impact on the results of my research or the nature of my findings. My background is retirement finance, and one of the key ways for people to have enough money to fund retirement is to make sure they manage their investments and debts carefully throughout their life.

Let’s be clear: borrowing against your house, like all borrowing, should be undertaken carefully. You should have a good budget in place, and be sure you’ll be able to stay current on your loan payments, even if your financial situation changes.

There are two common ways that homeowners can take advantage of the rate differential.

The first is a mortgage refinance, where a homeowner pays off the existing mortgage with a new one. If the new interest rate is sufficiently lower, the homeowner can receive a substantial cash payment while keeping the same monthly payment. There are some potential downsides to this option, however. Getting a new mortgage means you will have to requalify for the entire mortgage amount, which may be a challenge for homeowners whose financial situation has changed. In addition, refinancing your loan means resetting the clock for a new 30-year term.

A June 2019 report by Black Knight, a mortgage software and analytics company, found that there are 8.2 million homes that are “refi eligible” with rates at 3.75%. At 3.5%, that number increases to 11.6 million US homes. Black Knight defines “refi eligible” as any home with a mortgage at least 0.75% higher than the current mortgage rate.

The amount of savings a homeowner can gain from a refinance depends on the rate of their current mortgage as well as the size of the mortgage, but can quickly add up to tens of thousands of dollars.

The other way is with a home equity loan or home equity line of credit. Rates for these loans are typically higher than primary mortgages, but still much lower than typical unsecured loans. Since a homeowner is only applying for the additional amount they wish to borrow, they don’t need to requalify for their primary mortgage, and fees are typically lower.

In any case, homeowners should be clear on the opportunities available to them in the current interest rate environment, and make choices that best match their needs.