Back during the real estate bubble of 2007 when people were using their homes like giant ATM machines, cash-out refinancing was an easy way to pull some equity out of a home to finance vacations, home repairs, cars and pay off credit cards.
"Values were continuing to rise month after month with no end in sight," remembers Travis Saling, a loan officer at Sierra Pacific Mortgage in San Diego, Calif.
The larger home loans to cover that equity, however, created problems for many people who used risky loan programs "with the idea that they would simply refinance a few years into the new loan and get better terms or more cash out," Saling says.
Rebound after crash
The real estate market corrected itself in 2008, causing home values to crash and some homeowners to be upside down in their mortgage - owing more than their home was worth. Many walked away from their homes, and their mortgages.
As home values have been steadily increasing since the end of 2011, homeowners are again able to do cash-out refinancing loans while getting into more stable 30-year fixed mortgages, Saling says.
It's simple math, says Matt Hackett, underwriting and operations manager at Equity Now, a direct mortgage lender based in New York that lends in six states. About half of its loans are for cash-out refinancing. "Home values are going up and people have more equity in a house," Hackett says.
For FHA and conventional loans, a borrower is required to have at least 15 percent equity in their home in order to do a cash-back refinancing loan, Hackett says. How much of that money they can tap is a personal preference, he says, depending on their view on housing values and if they're concerned about being "underwater" in their mortgage. For a VA loan, a borrower may tap the full equity available in the home.
A minimum loan amount isn't required, though closing costs should be weighed against the cash out amount, Hackett says.
Stricter requirements by lenders for all types of loans, including cash-out refinancing, can make getting a home loan more difficult now than it was a few years ago. Cash-out refinancing, however, shouldn't be any more difficult than it was before the housing crash, experts say, because the qualifying rules remain the same.
Reasons for cash-out refinancing
Using the money for home improvements seems to be one of the most popular reasons for cash-out refinancing, mortgage lenders say.
"An overwhelming majority of my clients are telling me they plan to put the money right back into the home," Saling says. "They are going to do some upgrades they have been putting off for several years."
Paying a child's college tuition is another reason, and lenders sometimes ask what the cash out is being used for, Hackett says. Using a home's equity to pay for a vacation doesn't make sense because the closing costs are too high to justify it, Hackett says.
"What they're doing should make sense," he says of the purpose for taking cash out of a home.
Some want to the money so they can buy a second home or investment property, Hackett says. Ellen Davis, a senior mortgage lender at Corridor Mortgage Group in Columbia, Maryland, says she's seen the largest increase in cash-out refinances for investment properties in the past year. Cash-out refinances that Davis has done have increased 20 percent in the last two quarters, she says.
"Purchasing an investment property requires a greater down payment than purchasing a home that you will live in," Davis says. "Refinancing at these historically low rates, even for a cash-out, can be a great way to purchase an investment property."
She's also seen ex-spouses from a divorce take cash out to buy out their former spouse's interest in the home. "We have seen more instances of one of the owners staying in the home, then selling the home and both parties purchasing new homes," Davis says.
Higher risk to lender
Cash-out refinancing, as with other types of home loans, can be more difficult to qualify for now because of stricter documentation requirements by lenders. Cash-out refinancing can cause a lender to take a harder look at a borrower because the potential risk to the lender is higher, Davis says.
"When a borrower wants to take cash out of their home they are increasing their overall debt picture, thus making themselves a greater credit risk for lenders of any type," she says.
Davis' rule of thumb for borrowers is to have good credit, low debt ratios and a good amount of equity in their home. Removing one of those three - such as by taking equity out of home with cash-out refinancing - can make it more difficult to get a loan, she says.
"It doesn't by any means knock you out of the game, it just means that a lender will review your documents and the overall numbers with greater scrutiny," Davis says.
Loan rates and terms aren't necessarily different for cash-out refinancing, she says. The best rates and terms will need great credit, low debt and high equity, Davis says.
She gave two examples of cash-out refinances that she just completed: The first was to cash out $125,000 to buy an investment property. The borrower received a loan rate of 3.5 percent on a 7-year adjustable refinance mortgage rate for having excellent credit, low debt and a lot of equity in their home.
The second person did a cash-out refinance to buy out their ex-spouse in a divorce. They took out $250,000 at 4.5 percent interest on a 30-year fixed mortgage, and had good credit, debt that was "a bit high," and not a lot of equity in their home, Davis says.
Rising home prices can give homeowners a chance to refinance their mortgage loan and get cash out for home upgrades they've been putting off for years. The Great Recession, Saling says, may have reminded homeowners that using their home equity for frivolous expenses can only get them in trouble.
"Today's borrowers seem to be much more cautious when it comes to taking cash out and tend to only want to do so if the money will be put back into the house," Saling says.
The days of using your home as an ATM machine are over, and that's a good thing.