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Possible Next Housing Problem? Cash-Out Refis

AEI/CRL: If lots of inflation-hit owners refinance to take cash out, their temporary financial fix may lead to foreclosure if the funds run out or their home value falls.

WASHINGTON – Inflation has hit many American households, and some homeowners see a cash-out refi – a refinance mortgage loan where they also take some additional equity out of their home to use for other things – as a possible cash-crunch solution.

But according to research by the American Enterprise Institute (AEI) Housing Center and the Center for Responsible Lending (CRL), that could cause a future problem for homeowners, lenders and the federal government.

Currently, non-bank lenders are making cash-out refinance mortgage loans guaranteed by the Federal Housing Administration (FHA) and Veterans Administration (VA) to cash-strapped homeowners – particularly low wealth and veteran borrowers and those in communities of color. It gives low-income families a quick influx of cash but also leaves them with a mortgage that’s more expensive than the one they had before the refi.

Researchers say that “raises concerns that government-guarantee policies are promoting the use of ‘the house as an ATM’ by lower-wealth, cash-constrained buyers.”

CRL and AEI found about 13,000 FHA and VA cash-out refinances per month, which would translate to about 160,000 over the next year if the pace continues.

To add to the problem, the composition of FHA and VA cash-out refinance borrowers has shifted over the past two years to approve lower FICO score borrowers: The average FICO score for an FHA cash-out refinance loan dropped from 671 to 637, while the average FICO score of borrowers obtaining a VA cash-out refinance loan fell from 730 to 675.

Financial trap of cash-out refinances

“A broader availability of HELs (home equity loans) and HELOCs (home equity lines of credit)  at risk-based, market interest rates will save consumers money and preserve their equity while opening up a new line of business for financial institutions,” says Ed Pinto, director of the AEI Housing Center.

“Even at interest rates closer to credit card rates, HEL and HELOC loans allow FHA or VA borrowers to access their home equity at a lower overall cost than the cash-out refinance loans currently being marketed by non-bank lenders.”

AEI offers a cash-out refinance explainer video on YouTube.

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