The name itself conjures up images of ATMs: cash-outs.
You may associate the term “cash-out refinancing” with the frothy and dangerous days of the real estate boom, when some owners turned their hyperinflating houses into money mills, leveraging their equity to the hilt. That didn’t end up too well for many of them.
But now that equity holdings in homes are surging again, cash-out refinancings are coming back into vogue. Two big differences this time: The transactions are being made under much tighter controls by lenders, and the proceeds are being used by borrowers for saner purposes than they were last decade.
Giant mortgage lender Quicken Loans estimates that about a quarter of new refinancings are cash-outs. Federally chartered investor Freddie Mac reports that cash-outs grew to 17 percent of all refinancings in the first quarter of this year, compared with 14 percent during the same period in 2013.
A cash-out refi means that the homeowner borrows more money in a replacement mortgage than the current mortgage’s balance. (Other refinancings involve simply lowering the interest rate while keeping the principal amount the same as it was before.)
Say you have a home loan with a $200,000 balance. Thanks to rising home values, your property is worth $400,000. If you have a need for cash and good to excellent credit scores, you might be able to negotiate a refinancing into a new fixed-rate mortgage of $250,000 or $300,000. Putting aside transaction costs, you’d end up with roughly $50,000 to $100,000 in cash at closing for whatever use you have in mind.
During the height of the boom years, according to Freddie Mac data, borrowers opted to pull out cash in 80 percent or more of all refinancings. (Freddie defines a cash-out refi as one where there is an increase in the principal balance of at least 5 percent over the previous balance.)
In the wake of the bust and recession, when U.S. homeowners lost close to $6 trillion in equity, cash-outs have been far fewer and tougher to obtain. Even this spring they’re just a fraction of total refinancing volume, and the purposes that borrowers plan for the cash they’re extracting have changed dramatically. Whereas a decade ago people were pulling out extra money to pay for consumer spending — cars, boats, vacations — bankers say today’s borrowers are focused on more financially sound uses.
Bob Walters, chief economist for Detroit-based Quicken Loans, says his firm is seeing “a lot of debt consolidation” using cash-out refinancings. The same is true at Insignia Bank in Sarasota, Fla. Charles Brown III, the bank’s chairman and chief executive, says “sophisticated” borrowers concerned about rising interest rates are consolidating high-cost credit-card, mortgage and other floating-rate debt into fixed-rate home loans. The replacement mortgages often carry 30-year rates ranging from around 4 percent to just below 5 percent, depending upon the borrowers’ credit and income profiles.
Cyndee Kendall, Northern California regional mortgage sales manager for Bank of the West, says a typical cash-out refi client today has a floating-rate second mortgage or equity credit line plus a first mortgage with an above-market rate and wants to roll those debts into a single, fixed-rate jumbo mortgage. The goal of such clients, she says, is to better manage their cash flow and protect against anticipated interest-rate increases as the Federal Reserve tapers its Treasury securities purchases.
Paul Skeens, president and owner of Colonial Mortgage, a lender in Waldorf, Md., is frequently seeing another type of cash-out client: recession-era real estate investors cashing in their chips. People who bought a house at bargain prices for little or no cash and who have built up equity during the past few years through loan amortization and property appreciation now want to extract cash to make new investments.
A recent client, for example, did a $170,000 cash-out refinancing on a house he purchased with a 3.5 percent FHA-backed mortgage in 2011. The owner paid off the $147,000 FHA loan balance and took out a new conventional mortgage of $170,000. After transaction costs, he walked away from the refi with about $20,000 in cash, which he plans to use for a down payment on another investment house. The rate on the new loan: 4.875 percent for 30 years.
Cash-out refis aren’t the right financial option for everybody, of course. A home equity line of credit may be more flexible and cheaper. But for fixed-rate debt consolidation or pulling money out of a successful investment, a cash-out refi is worth a serious look.
Ken Harney’s e-mail address is email@example.com.