Cash-Out Refnancing Still an Option for Some
Need money? Got equity in your home? A cash-out refinancing might be the right solution for you - and yes, it's still possible despite the collapse of housing values and credit markets.
Many might assume the cash-out refinance is dead, due to falling property values and tighter credit requirements. And yes, it's much harder to obtain than in the go-go days of the housing boom, when homeowners were tapping their home equity like piggy banks. But it's still available - for homeowners with good credit and equity in their homes.
According to Freddie Mac, 38 percent of homeowners who refinanced home loans in the second quarter of 2009 did so at a value at least five percent higher than their existing mortgage - essentially taking money out of the home. Although that's far lower than the 88 percent rate at the top of the housing boom in 2006, that still represents a sizeable fraction of homeowners who are drawing on at least some home equity when refinancing.
Borrowing against home equity
A cash-out refinance, simply put, is when a homeowner refinances their mortgage for more than they currently owe, and takes the difference in cash. In essence, they're borrowing against their home equity, just like in a home equity loan or home equity line of credit (heloc). But there are some key differences.
A cash-out refinance is exactly that - you refinance your existing mortgage and take cash out of the deal. Suppose you own a home worth $300,000 and still owe $100,000 on your mortgage. In a cash-out refinance, you could refinance into a new, $150,000 mortgage and pocket the $50,000 difference to do as you please - perhaps do some major renovations or pay for college for the kids, for example.
Essentially, you're taking out a loan against your home value - except that you're doing it in the form of a mortgage. That means you're taking out a new loan to replace the old one, at current interest rates - which are very attractive right now.
Current interest rates attractive
With 30-year fixed mortgage rates currently running in the low 5 percent range, well below their historical norms, you'd think that would be an attractive deal for many homeowners.
And it is. Except in the current housing market, many homeowners have little equity to borrow against. The collapse of housing prices over the past three years, and in the last 12 months in particular, have left many homeowners with little or no equity to borrow against, many of them even "underwater" on their mortgages, owing more than their property is worth.
A cash-out refinance differs from a home equity loan or home equity line of credit in that you're completely refinancing your mortgage - you're completely reworking the terms of your home loan, including how much you pay each month and for how long it will take you to pay it off, be it 15 or 30 years or some other term.
A home equity loan, on the other hand, is a second loan on top of your current mortgage - so you have a second payment to make. A home equity line of credit is similar, except it allows you to draw money when needed over a fixed period of time, rather than taking it out up front.
Equity loans often have higher rates
Home equity loans and HELOCs typically involve higher interest rates than a cash-out refinance, and generally must be repaid over shorter time periods - often 10-15 years. At the same time, they allow you to continue paying off your mortgage on its original schedule, rather than refinancing over what may be a longer period of time.
Cash-out refinances got a bad reputation during the housing balloon, when homeowners frequently refinanced their mortgages to tap the equity in rising home values to pay for vacations, cars, boats and other lifestyle indulgences. They're a major reason why many homeowners wound up "underwater" on their mortgages and in financial difficulty when housing prices collapsed. That collapse, and the mortgage defaults that resulted, are a key reason why many lenders are extremely reluctant to offer cash-out refinances today.
However, as mentioned above, a cash-out refinance is still available today for homeowners who have been in their homes for several years and still have considerable equity in the property, despite recent declines in home values. Areas where home prices have been more stable - such as the Washington, D.C., New York City, Dallas, and Denver - are more likely to find lenders willing to consider cash-out refinances and other home equity-type loans than places like Miami, Las Vegas, Phoenix and Las Angeles, where home prices have posted their steepest drops.
Know what you're borrowing for
One thing to keep in mind when seeking a cash-out refinance is the purpose you're seeking the money for. If you're looking to invest in something durable - like home improvements (an attractive possibility now with many skilled carpenters short on work), college expenses, medical care or investing in or starting a business - a cash-out refinance can provide a sensible way to raise the money. But for short-term expenditures like vacations or other lifestyle choices, it can be an expensive way to get cheap money - as the rising number of current mortgage defaults and foreclosures attests.