Stressed homeowners find cash-out mortgage refinances harder to get

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With interest rates plunging to near historic lows and millions of Americans losing their jobs or worried about a layoff, homeowners are looking to their home equity for money to stay afloat.

Unfortunately, the economic fallout from the COVID-19 pandemic is crushing mortgage refinancing. Lenders are more hesitant to approve refinancing applications as unemployment skyrockets and they’re toughening requirements for borrowers.

With a cash-out refinance, you replace your loan with a new one at an amount that’s higher than your current loan balance. You can withdraw the difference between the two mortgages and use the money to carry you through financial hardship.

Homeowners have a mountain of equity they can draw on. A recent study by the Urban Institute shows there is $19.7 trillion of tappable home equity available.

Here’s what you need to know about doing a cash-out refinance during the pandemic.

COVID-19 impact on mortgage refinancing

Mortgage rates dropped to near record lows. The 30-year fixed mortgage averages 3.58 percent nationally, according to Bankrate data. Mortgage refinance rates, are also low, with the average 30-year fixed refinance rate at 3.64 percent.

Low refinance rates have triggered a wave in applications. The Mortgage Bankers Association’s Refinance Index, which tracks refinance applications, rose 10 percent for the week ending April 10 compared with the previous week. The index is 192 percent higher over the same week a year ago.

Cash-out refinances reached a 10-year high in the fourth quarter of 2019, the latest figures available, according to Black Knight. Homeowners drew more than $41 billion in equity out of their homes in the quarter.

The surge of refinance applications has overwhelmed some mortgage lenders. But the backup appears to be slowly easing as lenders adapt to new ways of doing businesses under stay-at-home restrictions. Regulators have also relaxed rules to help consumers. The Federal Reserve System announced on April 15 that lenders will be allowed to postpone appraisals for 120 days after new mortgages and refinances close. In addition, 23 states now allow e-notarization of key mortgage documents.  A bill passed by the Senate would extend this to all states.

Still, you should expect a new mortgage or refinance closing to take longer than it would have during pre-pandemic days. But it may be worth the wait and extra hassle.

“There is a population of homeowners who will stomach a more-complex mortgage process in order to take advantage of very low interest rates and the opportunity to save a lot of money,” says Austin Kilgore, director of digital lending at Javelin Strategy & Research.

When does a cash-out refinance make sense for you?

Make sure you know when cash-out refinancing is a smart decision. First, know whether you’d qualify for a refinance. Unfortunately, you can’t refinance if you’re in mortgage forbearance. As of April 16, more than 2.9 million homeowners were in forbearance plans, representing 5.5 percent of all active mortgages, according to data firm Black Knight.

“Many homeowners remain rightfully squeamish about cashing out equity from their homes,” says Greg McBride, CFA, Bankrate chief financial analyst.  “And it is not to be taken lightly, particularly if you’re using that equity and your home as collateral to pay off unsecured debt.”

Keep in mind that many lenders now enforce stricter mortgage qualifications. Ask your lender about refinancing requirements, as many are changing policies right now.

Many people use a cash-out refi to consolidate debt, pay medical expenses or meet other financial goals. In these cases, a cash-out refi may provide cheaper access to money than any other type of long-term borrowing.

“It can be a low-cost source of cash,” McBride says. “Particularly for homeowners that are short on liquidity but high on equity.”

Before you refinance, estimate how much you need and how much equity you have in your home. Equity is the difference between your current loan balance and your home’s value. Most lenders restrict you to keeping at least 20 percent equity in your home when you do a cash-out refinance.

Moreover, you can deduct mortgage interest from your taxes if you use the cash-out refi money for certain home improvement projects. In turn, these may increase your home’s value.

Risks and costs of cash-out mortgage refinancing

There are some risks involved with a cash-out refi. One is potentially paying more interest in the long run. A cash-out refi can mean resetting your new loan’s term back to 30 years to make the payments affordable. If at all possible, try to refinance to a term equal to what you currently have left on your original mortgage, or better yet, an even shorter term.

However, if your new interest rate would be higher than what you currently have, you may want to seek other options for the cash you need right now. Consider a personal loan or even a 0 percent introductory APR credit card if you can qualify.

A cash-out refinance comes with many of the same fees as your first mortgage. These include application fees, origination fees, appraisal fees, and more. Keep in mind you’d also pay closing costs on the whole loan amount. That includes your old loan balance and the money you “cash out.” If you had a $150,000 balance on your old loan and cashed out $50,000, then you’ll have to pay 2 to 6 percent in closing costs on the entire $200,000.

So examine all your options. And make sure you crunch all the numbers to ensure you’re actually saving money and meeting your current goals. Our mortgage refinance calculator can help you decide.

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