For thousands of American homeowners, the question is not whether to refinance their mortgages but whether to pull extra cash out when they do.
Put another way: Despite the recent uptick, mortgage rate decreases since the summer have rendered the refinancing question a no-brainer for lots of people. If you can cut your fixed mortgage rate from the mid- or upper 7% range to the mid- to upper 6% range at a cost you can recoup in 12 to 18 months, then the answer is virtually always yes.
But what happens to the equation when you--like many other homeowners--are tempted to take out extra money, beyond your current total mortgage debt, to use for some non-housing purpose?
Say you have a $200,000 home with an existing $140,000 first mortgage at 8%. You know you can save a bundle by refinancing into a new 30-year $140,000 mortgage at 6 3/4%.
But what if you want to pull more cash out of the transaction--say $20,000 to $30,000 to help pay for the kids’ tuition, to invest or to buy a new car? Are you going to have to pay more? The answer is not so simple.
The automated underwriting systems widely in use and connected to mortgage industry giants Fannie Mae and Freddie Mac will evaluate--and price--you differently when you want to pull extra cash out. Ditto for most large mortgage companies that sell their loans into pools that become bonds on Wall Street.
But some lenders--up to a point--won’t charge you extra, or hold it against you, if you want some more cash in your pocket. Here’s a quick overview of what to expect in the little-charted financial territory known as cash-out refinancing: Both Fannie Mae and Freddie Mac are happy to buy mortgages involving cash-out refinances. But executives at both companies say that cashing-out increases your statistical probability of default down the road. As a result, you may have to pay a bit more on the rate from the lender who sells your loan to either Fannie or Freddie.
For both companies, a key factor is your “loan to value” ratio or LTV. Once you push your LTV over 75% through a cash-out, you’re highly likely to be asked to pay a premium on your rate.
How much of a premium depends on contractual arrangements with individual lenders and on your overall risk profile, according to both companies. But mortgage industry sources say one-quarter of 1% extra on the rate would be a typical surcharge.
In the $200,000 example above, once you took your loan above $150,000 (75% LTV) to $160,000 (80% LTV), you’d probably trigger an extra quarter of a percentage point on the rate. Instead of a 6 3/4% quote from your lender, in other words, you’d get 7%.
The rationale? In the words of Fannie Mae Vice President Frank DeMarais, “It’s a fairly well-documented risk factor” that when people pull out mortgage cash for non-mortgage purposes, the likelihood of default increases.
DeMarais also noted that in most refinancings, “there’s a push on the appraisal"--subtle or unsubtle pressure on the appraiser to deliver a valuation that supports the amount needed to close the loan.
The potential risk from such a “push” is heightened further when the refinanced mortgage balance is larger than the balance before the refinance. Was that $200,000 house in the example really a $200,000 house, or was it a bit of a stretch from its true market resale value of $190,000 to $195,000?
The higher the debt against that property, the higher the risk of loss--and the size of the loss--to the lender in the event of a foreclosure.
Freddie Mac’s automated underwriting system approaches cash-out refinancing much as Fannie Mae does. But a Freddie Mac spokeswoman, Sharon McHale, emphasized that the electronic system’s complex evaluations of each loan application “could very well” end up charging a borrower little or nothing extra for a modest cash-out above the 75% LTV guideline. People with particularly high credit scores, for example, said McHale, might pay nothing extra on a cash-out.
What about cash-out refinancing pricing in the so-called “jumbo” loan market? According to Michael Covino, president and CEO of LuxMac, a New York-based jumbo mortgage lender, the range in rate premiums for loans in the $500,000-and-up category typically is one-quarter to three-quarters of a percent, depending on the loan-to-value ratio and the amount being cashed out above the previous balance.
The lower the LTV, the smaller the cash-out, and the more sterling the credit profile of the applicant, the lower the premium.
Should you take cash out when you refinance? If your LTV and credit scores qualify you for cash-out at a low premium and you have a good use for the money--like paying down high-rate consumer debt--why not?
Distributed by the Washington Post Writers Group.
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Average Mortgage Rates and Indexes
Weekly Survey of 90 Southland Lenders as of Oct. 8, 1998*--*
Latest One Week Six Months week previous previous Rates for loans under $227,150 30-year fixed 6.63%/1.94pt 6.15%/1.86pt 6.75%/1.98pt 30-year ARM start rate 5.36%/1.48pt 5.28%/1.51pt 5.67%/1.58pt 15-year fixed 6.30%/1.77pt 5.93%/1.42pt 6.53%/1.74pt Rates for loans over $227,150 30-year fixed 7.05%/2.04pt 6.56%/1.98pt 7.10%/1.97pt 30-year ARM start rate 5.43%/1.51pt 5.38%/1.53pt 5.68%/1.63pt 15-year fixed 6.74%/1.80pt 6.35%/1.76pt 6.84%/1.75pt FHA or VA mortgage average points 6.50%/1.91pt 6.50%/0.17pt 7.00%/1.54pt CALVET 30-year ARM start rate 6.95% 6.95% 6.95% 6-month LIBOR 5.156% 5.125% 5.688% 1-year Treasury bill 4.180% 4.410% 5.300% 6-month Treasury bill 4.100% 4.330% 5.010% 6-month certificate of deposit 5.080% 5.090% 5.580% Prime rate 8.250% 8.250% 8.500% 11th District cost of funds 4.899 4.911 4.968 For the month of Aug. ’98 July ’98 Feb. ’98
Compiled by Mortgage News Co., Morro Bay, Calif.