Mortgage Equity Withdrawal: What It is, How It Works

What Is a Mortgage Equity Withdrawal

Mortgage equity withdrawal is an economic metric representing the net amount of cash equity that consumers withdraw from their homes through home equity loans, or lines of credit, and cash-out refinances.

Mortgage equity withdrawals are a relevant economic indicator in forecasting consumer spending and, therefore, gross domestic product (GDP), which is the total economic output of goods and services, often expressed as a percentage.

Understanding Mortgage Equity Withdrawal

A mortgage equity withdrawal involves withdrawing a portion of a home's value or equity. For example, if a consumer has a mortgage loan balance of $200,000 and the home's value is $300,000, the consumer could extract a portion of the $100,000 difference in equity. If the borrower extracted $50,000, the money could be in the form of a home equity loan, home equity line of credit, or cash—called a cash-out refinance. If the borrower opted for the cash, a new $250,000 mortgage loan would replace the original loan at the new interest rate.

Mortgage equity withdrawal is cyclical and varies based on rising home prices and, to some degree, the overall level of interest rates. For instance, if interest rates fall, homeowners may be incentivized to refinance via their mortgage lender and take some cash out while still maintaining lower monthly payments than they were making before. People may use this extra cash to make large purchases like cars, appliances, remodels, or vacations.

However, even in a rising-rate environment, cash-out refinances are common, particularly if home prices have risen, creating more equity. In 2022, as the Federal Reserve increased interest rates to battle inflation, mortgage originations declined, and cash-out refinances outpaced traditional, non-cash-out refinances.

Mortgage Equity Withdrawals and Consumer Spending

An interesting feature of mortgage equity withdrawal when applying it to economic forecasting is calculating what percentage of the total equity withdrawal goes directly into consumer spending and what percentage is used to pay down existing consumer debt. Mortgage lenders market loans heavily to consumers for both reasons.

Another interesting feature of mortgage equity withdrawal when applied to economic forecasting is that consumers do not generally spend all of their withdrawals at once. In 2020, the Federal Reserve conducted a study that showed that the average home equity extraction was $40,000-to-$50,000. Of that money, consumers spent slightly more than $10,000 right away on housing expenses and home repairs while spending roughly $2,000 on other expenses.

Why Consumers Make Mortgage Equity Withdrawals

When consumers take out loans or other forms of financing against the equity in their homes, they free up money for home improvements, renovations, and investments elsewhere. Homeowners who take out a second mortgage after paying off the first mortgage may be seen as less of a credit risk and, thus, benefit from more favorable interest rates.

A rise in mortgage equity withdrawals can be an indicator of consumer spending and consumer confidence. Taking equity out of a home that is partly paid off can bring new risks to the homeowner as they take on new debt. There could be market fluctuations in interest rates, leading to a higher rate for the new loan. Also, a borrower might become unemployed or experience a reduction income that would affect their ability to repay the new debt. As a result, they also face renewed risk of foreclosure if they defaulted on their payments.

There is some debate on whether or not mortgage early withdrawals should be regulated, similar to retirement accounts. With many types of retirement accounts, there are stipulations and penalties for early withdrawals. Usually, there are no such restraints on mortgage equity withdrawals. As a result, homeowners could wipe out the equity value they've built up in their homes, which might have been used for their retirement needs. Furthermore, these equity withdrawals could be contributing factors in housing bubbles.

The Bottom Line

Mortgage equity withdrawal represents the aggregate amount of cash that a nation's homeowners withdraw from their home equity through refinancing or lines of credit. Mortgage equity withdrawals tend to rise when interest rates fall. However, cash-out refinances can be common even with higher rates if housing prices have risen. Mortgage equity withdrawal is studied when analyzing consumer spending patterns, particularly how much of the total equity withdrawals lead to higher consumer spending.