Is the Recent Refinance Boom the Reason We're Stuck With Sky-High Inflation?

When mortgage rates plunged to record lows in 2020, many homeowners were quick to refinance their mortgages. Some opted for a traditional refinance. But many borrowers went with a cash-out refinance instead.

A cash-out refinance allows borrowers to take cash out of their home by tapping existing equity. Someone with a home worth $500,000 and a mortgage balance of $250,000 might, for example, do a cash-out refinance where they borrow $300,000. The first $250,000 in that case is used to pay off the existing mortgage, and the remaining $50,000 can be taken as cash and used for any purpose.

During the fourth quarter of 2020, 38% of mortgage refinancers did a cash-out refinance, says Freddie Mac. And the share of refinance mortgages that were of the cash-out variety increased to 42% in 2021, when mortgage rates were still quite low.

Not surprisingly, these days, a cash-out refinance is a less attractive option given where mortgage rates are at. But all of the cash-out refinances that happened in 2020 and 2021 may have helped contribute to the higher levels of inflation consumers have been grappling with since mid-2021.

How cash-out refinances tie into inflation

The rampant inflation we've been experiencing has really boiled down to supply and demand. Consumers were flush with cash from stimulus aid in 2020 and 2021, and many increased their spending at a time when supply chains were suffering. That supply-demand disconnect allowed consumer prices to soar.

Meanwhile, supply chains opened up in 2022, and bottlenecks have since continued to improve. Throw in the fact that there's been no federal stimulus aid to come through since March 2021, and you'd think inflation would've cooled more by now. But a big reason why inflation has remained high could be a matter of homeowners sitting on excess cash from the refinances they did in 2020 and 2021.

Those who took cash out of their homes when the opportunity was there may be continuing to spend it to this day. And let's also remember that home values soared in 2021 as buyer demand increased due to low mortgage rates. So those going the cash-out refinance route may have been able to score a lot of spendable cash in the process.

An ongoing problem

Although inflation has cooled since peaking in 2022, we're nowhere close to the ideal 2% inflation mark the Federal Reserve likes to target. In April, the Consumer Price Index (CPI) had annual inflation measured at 4.9%. That's better than the 9.1% CPI reading we saw in June 2022. But clearly, it's not a complete improvement, either.

In time, inflation levels should taper off. And the Federal Reserve will no doubt do what it needs to do to make that happen, even if it means raising interest rates yet again. But it may take a while to get to a place of more moderate inflation, at least partly due to homeowners having cash at their disposal from refinance activity a few years back.