Compulsive Cash-Out Refinancing is a Risky Scenario

Frequent cash-out refinancing can be a financially risky strategy, because a cash-out refinance can bleed the equity out of your property. Before doing a refinance of any kind, it's important for homeowners to carefully study the bottom line and the long-term repercussions of such a move.
 
Cash-out refinancing is a specific way to do a mortgage refinance that results in the borrower walking away from the closing table with extra cash in hand. The way it works is that the mortgage company lends money against accumulated equity that exceeds the amount of the existing loan balance. The leftover portion is given to the borrower at closing in the form of a cashier's check, and becomes part of the newly refinanced mortgage principal.

Aggressive mortgage refinance

Before the real estate bubble burst, lenders were aggressively encouraging cash-out refinance strategies as a way to take advantage of rising home prices without having to sell one's home. The formula led to the widespread notion that a cash-out refinance was the next best thing to having a private ATM machine. But within the past two years, the risk of compulsive refinancing has been solidly and tragically confirmed, and the cash-out refinance will go down in the financial history books as one of the most innovative, but risky, mortgage refinance products ever invented.

Pitfalls of cash-out refinances

While a cash-out refinance mortgage is convenient, it may be too convenient.  Using credit cards is a great way to simplify your financing, but it can lull you into a false sense of financial security.  The cash-out refinance is a similar trap-it's a much too easy way to deplete your real estate equity. Plus, if home prices fall, which they can easily do because of the cyclical nature of the markets, it creates not one, but two adverse effects.

First of all, the equity falls, despite the fact that the homeowner may have already spent it in the form of cash taken through the cash-out refinance. Second, the collateral for the refinanced loan becomes devalued, making it difficult or even impossible to sell the home to come up with enough cash to pay off the refinanced mortgage.
Without being able to pay off the loan, and with no extra equity to borrow against in time of need, the homeowner is left with no options that can actually solve the problem. Even selling the home doesn't work, so foreclosure and a ruined credit rating is inevitable.

Another aspect of any repeated refinance strategy-whether housing prices rise, fall, or hold steady-is that each time a borrower refinances, she pays significant closing costs. The money she's trying to save can easily be negated by those refinance fees. The natural response of many consumers is to try again, hoping to improve their chances with yet another refinance. Do that a few times, and it's possible to spend so much money paying for refinanced loans, it can take decades to break even.