WASHINGTON — The name itself conjures up images of ATMs: cash-outs.
You may associate the term "cash-out refinancing" with the frothy and dangerous days of the real estate boom, when some owners turned their hyper-inflating houses into money mills, leveraging their equities to the hilt. That didn't end up too well for many of them.
But now that equity holdings in homes are surging again, cash-out refinancings are coming back into vogue — this time under much tighter controls by lenders and used for saner purposes by borrowers than they were last decade.
Giant mortgage lender Quicken Loans estimates that about one-quarter of new refinancings are cash-outs. Federally chartered investor Freddie Mac reports that cash-outs grew to 17% of all refinancings in the first quarter of this year compared with 14% the same period in 2013.
A cash-out refi means that the homeowner extracts more money in a replacement mortgage than the current balance, rather than simply lowering the rate and keeping the principal amount the same as it was before the transaction.
Say you have an existing loan with a $200,000 balance. Thanks to rising home values, your property is worth $400,000. If you have a need for cash and good to excellent credit scores, you might be able to negotiate a refinancing into a $250,000 or $300,000 new fixed-rate mortgage. Putting aside transaction costs, you'd end up with roughly $50,000 to $100,000 in cash at closing for whatever use you have in mind.
During the height of the boom years, according to Freddie Mac data, in 80% or more of all refinancings borrowers opted to pull out some cash. Freddie defines a cash-out refi as one in which there is an increase in the principal balance of at least 5% over the previous balance. In the wake of the bust and recession, when owners in this country lost close to $6 trillion in equity, cash-outs have been far fewer and tougher to obtain.
Even this spring they're just a fraction of total refinancing volume, but the purposes that borrowers plan for the cash they're extracting have changed dramatically. Whereas a decade ago people were pulling out extra money to pay for consumer spending — cars, boats, vacations — bankers say today they're focused on more financially sound uses.
Bob Walters, chief economist for Detroit-based Quicken Loans, says his firm is seeing "a lot of debt consolidation" using cash-out refinancings. The same is true at Insignia Bank in Sarasota, Fla. Chief Executive and Chairman Charles Brown III says "sophisticated" borrowers concerned about rising interest rates are consolidating high-cost credit card, mortgage and other floating-rate debt into fixed-rate home loans. The replacement mortgages often carry 30-year rates from the low 4% range to just below 5%, depending upon the borrowers' credit and income profiles.
Cyndee Kendall, Northern California regional mortgage sales manager for Bank of the West, says a typical cash-out refi client today has a floating-rate second mortgage or an equity credit line plus a first mortgage with an above-market rate and wants to roll those debts into a single, fixed-rate jumbo mortgage. They do it, she says, to better manage their cash flow and protect against anticipated interest-rate increases as the Federal Reserve tapers its Treasury securities purchases.
Paul Skeens, president and owner of Colonial Mortgage Co., a lender in Waldorf, Md., is seeing another frequent use of cash-outs: recession-era real estate investors cashing in their chips. People who bought a house for little or no cash at bargain prices during the recession, and who have built up equity during the last few years through loan amortization and property appreciation, want to extract cash to make new investments.
A recent client, for example, did a $170,000 cash-out refinancing on a house he purchased with a 3.5% FHA-backed mortgage in 2011. The client paid off the $147,000 FHA loan balance and took out a new conventional mortgage of $170,000. After transaction costs, he walked away from the refi with about $20,000 in cash, which he plans to use for a down payment on another investment house. The rate on the new loan: 4.875% for 30 years.
Cash-out refis aren't the right financial option for everybody, of course. A home equity line of credit may be more flexible and cheaper. But for fixed-rate debt consolidation or pulling money out of a successful investment, a cash-out refi is worth a serious look.