In an article published last month in USA Today Sheila C. Bair, Fannie Mae Board Chairwoman, writes that in many cases a cash-out refinance makes sense, allowing a family to cover a medical emergency or a longer-term investment such as a college tuition or a home renovation. But cash-out refinances can also carry risks every homeowner and every lender should consider, especially during times of rapid home price increases such as now.
Risks of Quick Cash
Ms. Bair goes on to say the first risk is simple – home prices go up and they go down. We’ve seen many cycles over the past few decades where home prices in many major markets dropped significantly. If a home’s value falls below the loan’s value, the borrower’s equity vanishes.
The second risk is using a home’s equity for quick cash instead of a cushion or a tool for building wealth. In a worst case scenario, a homeowner might decide to the use the family home as an ATM machine, taking out large amounts of money and making a risky assumption that housing prices will keep going up indefinitely.
Between 2005 and 2007, in the run-up to the Great Financial Crisis, millions of borrowers extracted equity from their homes, fueled by skyrocketing prices, lax lending standards and speculative investors. Irresponsible lenders profited, but borrowers had to live with the fallout.
Pitfalls of Cash-out Refinancing
According to Ms. Bair, homeowners considering a cash-out refinance need to keep the following key facts in mind:
A mortgage is secured by your home.
- Unlike credit cards and other loans, missing a monthly payment on your cash-out refinance loan could cost you your home.
Refinancing is not free.
- Typically, closing costs run from 2% to 5% of the loan amount, skimming off some the homeowners’ equity. In addition, while Fannie Mae and Freddie Mac won’t back a cash-out refinance loan with less than 20% equity, if a homeowner and lender choose to go that route, the homeowner should expect an annual mortgage insurance premium of 0.40% to 2.50% of the loan balance.
Home prices can fall.
- No one knows for certain where housing prices are headed. Anyone who says otherwise might not have your best interest at heart. Fannie Mae economists believe that home prices will continue to grow through the end of 2022. But that’s just a projection, and if you enter into a cash-out refinancing assuming it’s a certainty, you could be putting your home at risk.
Houses require upkeep.
- Roofs need to be repaired. Aging appliances need to be replaced. Maintenance costs can be expensive. By preserving home equity, families have a resource they can tap to make needed investments in their homes to maintain and enhance their property.
There are other refinance options.
- A non-cash refinancing that lowers your interest rate can lower your monthly house payment, taking pressure off your budget. A refinancing that shortens your term can help you build equity faster.
Homeownership, Ms. Blair states, can be one of the most effective ways of building wealth. However, entering into a long-term mortgage and building equity requires care and diligence. But the payoff in the years to come can be tremendous, helping families weather financial shocks and save for things like retirement and even passing on wealth to children or grandchildren. Pulling cash out of a home puts those long-term benefits at risk, so weigh the costs, benefits and risks carefully. (Sheila C. Bair is the chairwoman of Fannie Mae’s Board of Directors and former chairwoman of the Federal Deposit Insurance Corporation.)
According to RE/MAX Metro realtor Estelia Mesimer, the two biggest reasons not to enter into cash-out refinancing are:
1.) Foreclosure risk: Because your home is the collateral for any kind of mortgage, you risk losing it if you can’t make the payments.
2.) Private mortgage insurance: If you borrow more than 80% of your home’s value, you’ll have to pay for private mortgage insurance.
If you’re interested in any of these of communities or live in one of them and are thinking of selling, call Estelia today!
Greater Pinellas Point
Historic Old Northeast
Historic Roser Park
Isla del Sol