Sunday, April 12, 2009

No More "Cash Out" Refinancing

A hallmark of the great debt-binge era of 2004 – 2008 (R.I.P.) was the “cash out” home refinance. The idea is simple: the owner takes out a new loan higher in amount than the previous loan and pockets the difference in cash.

As a property rose in value, the owner was able to take on more debt – and to buy vacations, luxury vehicles – and maybe even a new investment property so they could repeat the cycle all over again.

Money, created when banks relaxed their lending guidelines, was used to make money and more money until the merry-go-round stopped.

Now, it’s all but impossible for owners – even with superior credit – to get a cash-out refinance.

Banks are understandably leery about lending money on an asset that, in most areas, is losing value, especially as it is far from clear when the real estate market will bottom out.

Studies have also shown that borrowers who need to take cash out of their homes when they refinance have higher default rates than those who do not.

[Banks] will often lend up to only 60 percent of the home’s value, while others place a cap of $100,000 on the amount of cash a borrower can extract from the home.

Homeowners who do find a lender willing to offer a cash-out refinance should be prepared to pay a higher interest rate than they would pay if seeking a conventional refinance loan.

Those with good credit — and credit scores of at least 720 — can expect to pay an additional three-fourths of a percentage point. Borrowers with lower credit scores face much worse conditions. [New York Times]

It’s an unfortunate by-product of the mortgage meltdown and credit crisis that qualified borrowers cannot easily tap the equity in their property.

This “easy money” can be put to useful purposes. Yet it was so abused during the boom that cash-out refinances are likely a primary cause of the short sales, foreclosures and underwater mortgages prevalent today.

Less home equity to tap means less money circulating in the US economy. It’s no surprise car and retail sales are hitting all-time lows because the “home as ATM” has been taken away from the American consumer.

With “returns” from homes and investments sorely negative, the harsh reality for most Americans is that they’ll have to earn money the old-fashioned way: with hard work.