Increased equity driven by higher home values and recovering credit scores are creating increased demand for cash-out refinacings, which have risen to a post-recession high.
Cash-out refinancings are being used more often than anytime since the end of 2008, when the housing boom ended and the Great Recession of 2008 was just getting started.
Forty-nine percent of all home refinancings in the first quarter of 2017 involved cash-outs, according to Freddie Mac — the highest percentage since the end of 2008. The peak for cash-outs was the third quarter of 2006 when 89 percent of home borrowers took cash out.
As a home rises in value and homeowners gain more equity in their home loan, refinancing allows borrowers to replace their mortgage with a larger one while using the difference between the old balance and the new mortgage to spend however they wish. They’re commonly used to pay for college, home repairs and paying off debt such as credit cards.
For example, if you have a $150,000 mortgage balance and your home value is $250,000, you have $100,000 in home equity, or 40 percent of the home’s value.
You generally want to retain at least 20 percent equity after refinancing, so in the above scenario you’d have $50,000 available to borrow and pull out in cash. Your new mortgage would be for $200,000, though this doesn’t account for closing costs that can be rolled into the mortgage.
Other types of cash-out refinancing include a home equity loan or a home equity line of credit, or HELOC.
What it means to homeowners
Rising home prices are responsible for most of the cash-out increases, though only if borrowers have built up enough equity, says Raymond Eshaghian, president and CEO of Greenbox Loans in Los Angeles.
“Without equity there’s no cash out,” Eshaghian says.
Having enough equity can make it easier for people with less than perfect credit to take cash out of their home, he says, allowing them to consolidate debt and clean up their credit.
“We’re seeing a lot of borrowers who want to take money out and take care of financial obligations,” such as credit card debt, says Eshaghian, whose company specializes in non-qualified mortgage loans.
Rising home prices and low interest rates make cash-out refis appealing, especially for people with low credit scores who may not have qualified for cash-out refis until recently, says Ed Hoffman, president of Wholesale Capital Corp. in Moreno Valley, Calif.
“A 580 (credit) score is not someone who’s a complete derelict but is someone who has had some challenges” and needs help, Hoffman says.
Someone who went through a foreclosure, bankruptcy or other major financial event years ago during the housing crisis may now be able to get back into the housing market, creating a higher demand than there is of supply and pushing home prices up, Hoffman says.
“As a result, homeowners who have already bought and don’t want to sell now find themselves with a significant increase in equity they didn’t have before, and it’s available for cash out refis,” he says.
Lenders aren’t necessarily offering incentives for cash-out refis or reducing the qualifications, “but it’s certainly much easier to qualify a borrower for a $20,000 cash out to pay off their car if they have $60,000 of equity in their house,” Hoffman says. “That’s what’s accounting for the increase.”
Less cash out than in previous years
FHA mortgages allow 85 percent cash outs, meaning that only 15 percent equity is required in FHA loans, Eshaghian says. Most other loans allow 75 percent cash out and 25 percent equity, he says.
In 2008 up to 100 percent cash out was allowed, Eshaghian says. “That’s not really available today,” he says, with income verification and other documentation needed now. “You really didn’t have to do much to qualify back then,” he says.
Even though more people are taking cash out of their homes, they’re taking out less money. An estimated $14 billion in net home equity was cashed out in the first quarter of 2017, down from $19.1 billion in the fourth quarter of 2016, according to Freddie Mac. By comparison, $84 billion was cashed out of home equity in the second quarter of 2006.
Americans still had plenty of equity in their homes. Homeowners had $13.3 trillion in equity at the end of last year, up $1.3 trillion from the previous year, according to the Federal Reserve.
Refinancing a home loan and pulling out some of the equity in cash only makes sense if you’re taking out enough money to make the refi worthwhile, Hoffman says The average home loan costs $3,000 to refinance, so taking out 30 percent equity to borrow $10,000 doesn’t make sense, he says, but taking out $50,000 could.
Getting a lower interest rate on the refinanced loan also makes sense, Hoffman says, though by definition cash-out refis cost a little more in interest rates — 1/8 to 1/4 point higher — than a rate-term refi.
Borrowers can save more money in the long-term by refinancing to what their current loan term is for. For example, if you started with a 30-year home loan and are five years into it, refinance it as a 25-year loan instead of going back to a 30-year loan.
It’s also worth considering if you’re going to stay in your home for awhile, Hoffman says, adding that it could be advantageous to do a cash-out refi sooner rather than later if interest rates rise. “If they plan to stay in their house for awhile, they can wait it out,” he says of interest rate fluctuations.
For homeowners on the fence about a cash-out refi, Eshaghian says they shouldn’t worry that home prices have to continue rising to make a cash-out worthwhile. A stale market is fine, he says, as long as it doesn’t go down and force homeowners to be under water in their mortgage.
A home is put up as collateral in a cash-out refinance, so taking on the additional debt should be considered carefully and should be a monthly payment you can afford.