The New Dinosaur: Cash Out Refinancing

For homeowners, a cash-out refinance used to be the pot of gold at the end of the rainbow. In the days of sky-rocketing home values, this type of loan was an easy source of cash. But as the declining number of refinances indicates, times have definitely changed.

The late 1990s and early part of this decade were home equity heydays, a time when cash-out refinances and second mortgages flourished. Homeowners took advantages of rising real estate values that were growing at double-digit rates, and tapped their equity to fund their free-spending lifestyles.

The hoopla has faded over the past few years, as slumping home markets touched off the subprime lending crisis. People who'd been basing their lifestyles on increases in their homes' values suffered rude awakenings. The result has been a decrease in the number of cash-out refinances.

Going the way of the ARM?

The cash-out refinance is suffering a fate that's also being experienced by adjustable-rate mortgages (ARMs), loans that included low teaser rates that would adjust upward after an introductory period. At the end of the period, borrowers typically refinanced the loans to another loan with a new low teaser rate.

This formula worked if your home continued to appreciate in value, and you had enough equity to qualify for a new mortgage. However, ARM borrowers were stuck when their homes decreased in value, and they could no longer qualify for loans. As a result, the number of ARMs in lenders' portfolios has dramatically declined.

Cash-out refinance no longer in-vogue with lenders

The cash-out refinance has experienced a similar drop in originations. Lenders have reported that the amount of money cashed out by homeowners in the fourth quarter of 2007 had decreased by one-half from the fourth quarter of 2006. Homeowners and lenders, both feeling antsy about the marketplace, have driven the decline.

Unlike homeowners with ARMs, who needed to refinance because their rates were adjusting upward, many of the borowers who use a cash-out fixed-rate first mortgage aren't quite as desperate. Their loans aren't driven by teaser rates. Instead, they may use a cash-out refinance to fund a home improvement. But with home values taking a dive, many borrowers have been extremely reluctant to borrow against more of their home equity.

Lenders have grown gun-shy as well. Loan guidelines have tightened considerably-especially in areas of shrinking home values. With so many foreclosures tainting their portfolios, lenders are proceeding very cautiously. They're also tightening guidelines on second mortgages, including home equity loans and home equity lines of credit.

The home equity heyday may be a distant memory, but its fallout continues to be felt today. Borrowers and lenders walked hand-in-hand into a quagmire that's the subprime lending crisis. Our country will survive-it's faced financial crises of far greater magnitude. But the big question that remains is, will consumers learn from the shrinking number of cash-out refinances? And if so, will they remember the lesson the next time around?