People who used their home equity to refinance and pay down credit cards and car loans saw improvements in their credit scores, but the resulting larger mortgages brought risks for homeowners, according to a U.S. government report.
The report issued this month by the Consumer Financial Protection Bureau found that many homeowners who obtained cash-out refinances between 2014 and 2021 used the money to pay down their credit card and car loan balances. They also experienced “sharp increases” in their credit scores in the first three months after the refinancing.
In subsequent months, the amount people owed on their credit cards rebounded somewhat and their credit scores dropped again, but not back to the levels they were at before refinancing, the report said.
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Among homeowners who had credit card balances and did a cash-out refinance during that time period, more than 57% reduced their card balance by 10% or more. The average card balance decreased by more than $4,500 from the quarter before the refinance to the quarter afterward. Average car loan balances fell by about $3,000.
Home equity, or the difference between a house’s value and money owed on a mortgage, is the third-most common financial asset for families, the CFPB said. With rapid increases in home prices over the past few years, more owners are looking to tap into that equity to pay for other expenses.
When someone takes a cash-out refinance, their new mortgage will be larger to account for the amount of money they received in cash. That, combined with today’s higher interest rates, may put an owner more at risk of foreclosure if they can’t make regular payments, the report said.
Advocacy group Center for Responsible Lending cautioned against cash-out refinances for this reason in a 2023 report.
“Cash-strapped borrowers are being enticed into using the home equity they have accumulated as an ATM. With today’s higher mortgage interest rates, taking out these … refinance loans will damage their long-term financial health,” the group said in a statement.