The Nation's Housing

Cash-in refinancing could help homeowners save

By Kenneth Harney
Saturday, February 6, 2010

Thinking of cashing out some equity when you refinance your mortgage? Sure, that used to be what millions of homeowners did when they needed extra money.

But now get ready for the post-boom, post-crash trend that's really hot: Cash-in refis -- the complete opposite of cash-outs.

"It almost sounds un-American," jokes Frank Nothaft, chief economist for mortgage giant Freddie Mac. After all, Americans have grown accustomed over much of the past two decades to tapping into their equity -- pulling out a chunk of cash and adding to their debt load -- when they refinanced their mortgages. "Almost nobody thought of putting money back in," he says.

Cash-outs hit their highest level of popularity during the wild appreciation streaks in the early and middle years of the past decade. In mid-2006, just before home values began deflating across the country, the rate of cash-outs hit 88 percent, according to Freddie Mac, which monitors refinancings quarterly.

This meant that nearly nine out of 10 refinancers whose loan files were sampled by Freddie Mac increased the size of their mortgage balance by at least 5 percent. It was the heyday of the pile-on-more-debt mind-set -- cash me out, I can't lose on my real estate -- that came crumbling down in 2007 and 2008, when home equity holdings shrank drastically and painfully.

From 2005 to the third quarter of 2009, according to Federal Reserve estimates, American homeowners lost $7 trillion in equity -- an unprecedented evaporation of household wealth. Almost nobody was spared.

Now the pendulum in consumer psychology appears to be swinging toward reduction of household debt -- whether credit cards or mortgages. In Freddie Mac's latest quarterly survey of refinancings, 33 percent of homeowners put cash into the deal to lower their mortgage balances, the highest percentage ever. By contrast, only 27 percent of refinancers took cash out -- the lowest percentage on record.

Why throw money from savings into your mortgage? Nothaft says a small percentage of refinancers traditionally have preferred to lower their mortgage balances whenever possible -- including himself and his wife.

There are at least two key rationales for doing so, Nothaft says. No. 1: If interest rates are low and you're getting minuscule returns on your bank savings or money-market funds, paying down your home loan might well provide you a better return on your investment.

For example, in early 2009, Nothaft and his wife chose to lower their mortgage balance at the same time they were refinancing to 4.75 percent. "We thought, hey, this is a no-brainer," recalls Nothaft. "We can get a 4.75 percent return instead of close to zero" on checking accounts and bank deposits.

A second reason to consider a cash-in refi would be to qualify for a better interest rate and terms on the replacement mortgage. Say you've got a loan-to-value ratio above 80 percent and any refi of the current balance will require payment of private mortgage insurance premiums and possibly come with a higher rate.

But if you have some money that you could devote to lowering the principal balance -- cashing in -- you might be able to cut your LTV ratio to 75 percent or less, get a more favorable interest rate and avoid mortgage insurance premiums.

Cash-ins, in effect, are a disciplined form of saving -- one that in today's depressed rate environment for competing types of savings might be a heads-up financial management move.

Nothaft said he isn't sure whether the recent jump in cash-in refis is the start of a long-term societal shift. But there has been a steady rise since the fourth quarter of 2007, when cash-ins hit 9 percent, up from just 5 percent of all refis earlier that year.

By early 2009, they accounted for 13 percent of refinancings and then grew to 18 percent in the third quarter. After that, cash-ins jumped precipitously to 33 percent in the final three months of 2009.

"It may well be a reaction to higher credit standards by lenders" -- making cash-outs and refis in general tougher to get -- or "some decision on the part of many people to be a little more conservative in uncertain times," Nothaft says.

A cash-in refi is hardly a remedy for everyone -- most people don't have spare cash available to throw into the pot. But with mortgage rates widely predicted to rise from 5 percent for 30-year fixed rate at present to the mid- to upper 5s as the year progresses, the numbers just might work for you if you have the resources.


© 2010 The Washington Post Company