During the housing boom of the mid-2000’s, cash-out refinances became a popular outlet for homeowners. Homeowners were encouraged to think of their homes as ATM’s that they could easily withdraw cash from, in the form of a cash-out refinance.
For example, between 2000 and 2007, productivity grew 16%, but compensation grew just 9.4%, as measured by the Labor Productivity and Cost program. Because of that income deficiency, many people who had built up equity in their homes mined that equity in an effort to maintain or upgrade their lifestyles.
In fact, according to data from Royal Bank of Scotland (RBS), the total cashed out dollars has tumbled from a peak of $320 billion in 2006 to $32 billion in 2013.
RBS analysts say the decrease is due to three reasons.
1. Cash-out refinances are closely tied to increase in home prices.
Despite jumping 11.5% year-over-year nationally in 2013, inflation adjusted housing prices are still down about 30% from the bubble peak, according to RBS data.
In addition, RBS analysts don’t expect home prices to continually rise as they did in the bubble years, which could make borrowers less likely to withdraw equity from their homes. RBS projects home prices to increase by 4% in 2014 and 2% in 2015 followed by a 2% increase on average in the long term. As a result, many borrowers would still be unable to use cash-out refinances due to the lack of home equity.
2. The shift in borrower mentality from using their homes as an ATM.
Homebuyers are making more of a concerted effort to pay down or pay off their debts instead of expanding or upgrading. As lending standards tightened after the crash, borrowers’ credit quality has improved.
3. Cash-out refinances are not always cheap when compared to alternatives like home equity loans.
While the interest rates on a cash-out refinance are usually lower than those on a home equity loan, they can become expensive once additional loan level pricing adjustments are considered.
Depending on the FICO/LTV combination, the borrower could pay up to 3% of mortgage balance upfront or 0.75% additional annual interest rate for cash-out refinances. Additionally, cash-outs are not available to high LTV borrowers. The GSEs’ guidelines stipulate that cash-out refinances are not permitted for borrowers with LTV greater than 85. Finally, closing costs are required for cash-out refinances, but they are not needed for home equity loans.
Given these three factors, RBS concludes that it’s unlikely that cash-out refinances will return to the pre-crash level.
