In an effort to help homeowners leverage their home equity without forfeiting historically low mortgage rates, Freddie Mac has introduced a new second-lien mortgage product. This proposal comes as home equity has surged alongside rising property values.
The innovative product allows homeowners to access their home equity while maintaining their low interest rates on existing mortgages, presenting a cost-effective alternative to cash-out refinancing at current higher rates. According to the Urban Institute, "Freddie Mac’s proposal is more borrower friendly because it would allow the borrower to retain their first mortgage, with its attractive rate, while tapping into their home equity."
For example, a homeowner with a 3% mortgage rate on a $300,000 loan currently pays around $1,265 per month. If the property value increases to $500,000 and the homeowner opts for a cash-out refinance to access $100,000, the new $400,000 mortgage at a 7.25% interest rate would result in a monthly payment of approximately $2,729. Conversely, under Freddie Mac's proposed plan, the homeowner could keep their $1,256 monthly payment and take out a new 20-year mortgage for the additional $100,000 at a 7.25% interest rate, resulting in a total monthly payment of $2,130.
The Federal Housing Finance Agency (FHFA) is currently reviewing Freddie Mac's proposal, seeking public comments as it evaluates whether to approve the product for market release.
The Mortgage Bankers Association (MBA) has highlighted the "locked-in effect," where homeowners with low-rate mortgages are hesitant to sell or refinance. This has led to increased interest in second-lien financing options, such as home equity lines of credit (HELOCs) and other second mortgage products. These financial tools offer flexibility, allowing borrowers to access funds as needed and providing various terms and rates.
Freddie Mac's second mortgage would be a fixed-rate product available for up to 20 years. Borrowers must meet specific criteria, including holding the first lien with Freddie Mac, maintaining a combined loan-to-value ratio of 80% or lower, and agreeing to pay off the second lien upon refinancing, selling the home, or paying off the first lien.
Home Equity on the Rise
In 2023, the average U.S. homeowner gained approximately $24,000 in home equity, with significant increases in states like Rhode Island, New Jersey, and Massachusetts, each seeing gains of $50,000 or more, according to CoreLogic. This rise in home equity is attributed to record home prices, which have climbed 6.6% from the first quarter of 2023 to the first quarter of 2024, as per the Federal Housing Finance Agency (FHFA) House Price Index.
Selma Hepp, Chief Economist at CoreLogic, noted, "Rising home prices continue to fuel growing home equity, which, at $298,000 per average borrower, remained near historic highs at the end of 2023. By extension, at 43%, the average loan-to-value ratio of U.S. borrowers has also remained in line with record lows, which suggests that the typical homeowner has notable home equity reserves that can be tapped if needed. More importantly, home price growth over the last year has helped lift the equity of homeowners who were underwater because of 2022 price declines."
Freddie Mac's proposal aims to provide homeowners with a viable option to utilize their home equity while keeping their low-interest first mortgages, potentially offering a significant financial advantage in the current economic landscape.