June 28, 2021
Home prices have posted double-digit annual gains and homeowners are feeling richer. Those higher prices are also driving an uptick in cash-out refinancing, in which owners are taking out some of the home equity by refinancing.
In 2020, about $185 billion of equity was taken out through cash-out refinances—the highest amount since 2007, according to Fannie Mae and Freddie Mac.
But Fannie Mae’s board of directors chair Sheila Bair warns in a new column at Yahoo! Money that homeowners need to be careful about using cash-out refinances and taking out too much of their home’s equity.
“In many cases, a cash-out refinance makes sense, allowing a family to cover a medical emergency or a longer-term investment such as college tuition or a home renovation,” Bair writes. “But cash-out refinances can also carry risks that every homeowner—and every lender—should consider, especially during times of rapid home price increases such as now.”
After all, home prices can’t rise indefinitely and there’s always a risk with cash-out refinances that home values could fall below the loan’s value.
Stricter lending standards today than preceding the Great Recession are making it more difficult for some homeowners to transact a cash-out refinance. For example, Fannie Mae now requires that cash-out refinance loans be no greater than 80% of the home’s value and at least six months of verified reserves for homeowners whose monthly debt payments are 45% or more of their monthly incomes.
Lenders and homeowners are being more cautious: 36% of 2020 cash-out refinances resulted in a mortgage balance at least 5% greater than the previous balance. From 2005 to 2008, that comprised 78% of refinances.
“The overall picture of today’s cash-out refinance market is one calling for caution, but not alarm,” Bair notes.
Bair urges any homeowners considering a cash-out refinance to recognize the importance of not missing any payments—a missed monthly payment on a cash-out refinance loan could cost them their home—and to be aware that refinancing still costs money. Closing costs could make up 2% to 5% of the loan amount. Also, Fannie Mae and Freddie Mac will not back a cash-out refinance loan with less than 20% equity.
“Homeownership can be one of the most effective ways of building wealth,” Bair writes for Yahoo! Money. “However, entering into a long-term mortgage and building equity requires care and diligence.”
Source: “Tempted to Turn Your Home’s Soaring Equity Into Cash? Don’t Do it Lightly: Fannie Mae Chair,” Yahoo! Money (June 26, 2021)