Homeowners who have built a substantial amount of equity in their homes may be eligible to refinance their mortgage loan and cash out some of their equity. This is known as a cash-out refinance. But just because you can doesn't mean you should.
How Cash-Out Refinances Work
Cash-out refinances are similar to other refinances, except the homeowner actually borrows more than than they owe on their original loan.
For example, say your home is worth $300,000, and you owe $100,000 on your mortgage. If you get a new loan for $150,000, you can pull out $50,000 of your home’s equity in cash. Click here to read more about cash-out refinances on Bankrate.com.
Note:Texas has specific laws governing cash-out refinances and home equity loans, which prohibit homeowners from borrowing more than 80% of the value of their home. So if your home is worth $300,000, in Texas the maximum amount you can borrow is $240,000. This is true for both cash-out refinances and home equity loans. Texas homeowners must also have at least 20% equity in their homes to be eligible for a cash-out refinance or home equity loan.
For more information about Texas-specific restrictions on cash-out refinances and home equity loans, visit the Office of the Consumer Credit Commissioner's website.
The Risks of Cash-Out Refinances
Cash-out refinancing can provide homeowners with access to quick cash when they need it. And with continued low mortgage interest rates, many homeowners may be wondering if a cash-out refinance is a good deal for them.
While there are some circumstances in which a cash-out refinance makes sense, there are significant risks that each homeowner needs to consider when deciding whether to dip in to the equity in their home.
- When you cash out the equity in your home, you increase your amount of debt and erase the wealth you have built in your home.
- The payments on your new loan may be higher, and if you fall behind on your mortgage payments, you risk losing your home.
- If the value of your home declines, you are more likely to become underwater on your mortgage loan. If this happens, you will have trouble refinancing your loan or selling your home.
To fully appreciate the risks of cash-out refinancing, look no further than the most recent housing and financial crisis. According to an article published in the New York Times, cash out refinances comprised a large percentage of the sub-prime loans that eventually led to the crash of the housing market. Citing a joint HUD-Treasury report, the article notes that by the year 1999, 82% of sub-prime mortgages were refinances, and 60% of those refinances were cash-out refinances.
And according to an article published in April 2010 in the Washington Post, Texas' restriction on cash-out refinances and home equity loans played a major role in protecting the state from the worst of the housing crisis. Quoting research from the Federal Reserve Bank of Dallas, the article argues that fewer Texans cashed out their home equity in the early 2000s, and those who did were capped on the amount of equity they could cash out. The Federal Reserve Bank of Dallas' research also confirmed the risks associated with cash-out refinancing by finding a strong link between the percentage of subprime cash-out refinances in a state and that state's foreclosure rate.
While the federal government has cracked down on sub-prime lending, the other risks associated with cash-out refinances still remain. For more information about cash-out refinances and home equity loans, please see the additional resources linked below.
When is cash-out refinancing a good option?
Home equity loan, HELOC or cash-out refi?
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On the House blog posts are meant to provide general information on various housing-related issues, research and programs. We are not liable for any errors or inaccuracies in the information provided by blog sources. Furthermore, this blog is not legal advice and should not be used as a substitute for legal advice from a licensed professional attorney.