Meet the homeowners giving up 4% mortgages and opting for cash-out refis

For low FICO score borrowers who need a lump sum of cash, cash-out refis can be a sensible option, LOs say

In late August, when mortgage rates were well over 7% and beginning their climb toward 8%, Jeff Anderson had a client do what few other homeowners are willing to do: She gave up her 4% mortgage rate.

You’re probably thinking, “Uh, why on earth would she do that?” 

The client wanted to pay off $30,000 in consumer debt, handle home improvement projects and help her daughter start college, said Anderson, a longtime mortgage advisor in Southern California. By doing a cash-out refi, she landed a $340,000 FHA loan and locked in a 6.9% mortgage rate.

“At closing, my client will get $10,000 of cash up-front. We are paying off her current mortgage balance of $280,000 while maintaining more than $200,000 in home equity,” said Anderson, who runs the mortgage broker shop Rancho Capital Home Loans. “She would be saving $550 a month and lower[ing] her debt ratio to slightly below 50% from the current 57%. There is no shortage of cash for her right now.” 

A cash-out refi replaces the homeowner’s current mortgage with a new, larger loan under different terms from the original loan. In return, a borrower receives the cash difference between the new amount borrowed and the old mortgage balance.

When mortgage rates were at historical lows during 2020 and 2021, a record number of homeowners tapped their equity through cash-out refis and still managed to secure low rates on the new mortgage. In 2021, more than $1.2 trillion in cash-out refis were executed.

But since the cost of borrowing has skyrocketed due to the Fed rate hikes, there are far fewer homeowners willing to give up their sub 4% mortgage and refinance into a mortgage that’s at least 300 basis points higher.

Even though about 30% of mortgage applications are for refinancings, nearly 90% of current mortgage originations today are purchase loans.

But for some low FICO borrowers who need a lump sum of cash, a cash-out refinance can be a sensible option, thanks to their accrued home equity. (The average tappable home equity for homeowners was slightly over $200,000 in August 2023, up from $126,606 in August 2020, according to data from Intercontinental Exchange.) 

Of the overall equity withdrawals, home equity line of credit (HELOC) took up more than half (52%) of the share in Q2, with cash-out refis accounting for the rest. But, the profile of cash-out borrowers made up roughly 90% of all refis during that period, ICE noted. 

The average cash-out borrower looking to refinance had a balance of about $165,000 in August, well down from where it’s been over the past couple of years, Andy Walden, ICE’s vice president of enterprise research, said in an interview.

“They (cash-out refi borrowers) are not not giving up a record low interest rate on a significantly large balance, so they’re okay and are willing to give up that low rate that they have right now. About $100,000 on average is what they’ve been borrowing in recent months. They can get that equity withdrawal at a slightly better interest rate than what you could withdraw equity on a HELOC,” said Walden. 

Cash-out refis are not a fit for every borrower. 

There are alternative ways to tap into home equity without doing a cash-out refi. Home equity loans and HELOCs allow the borrower to borrow against the home equity without having to give up the existing mortgage. They are second mortgages, which means borrowers take them out in addition to their current mortgage.

The cash-out refi option works best for low credit score borrowers with at least 20% equity in the home to qualify, said John Ortega, a loan originator at Mutual of Omaha Mortgage.

Generally, borrowers need a debt-to-income (DTI) ratio of 40% to 50% or less and could qualify for a cash-out refi with a credit score of 620. Credit scores for FHA loan borrowers could go down even lower.

Some borrowers are handcuffed from negotiating a HELOC — the product typically requires a higher credit score — or other type of secondary lending, and are often left with no other option but to refinance.

For the clients that choose to get a cash-out refinance mortgage, Ortega shows how much they could save per month and potentially put the extra cash into paying off the mortgage sooner. 

“When you start to do the consolidation of all this debt, their credit scores will improve rather quickly and put them in a much better position for the future. That’s what it’s really about, it’s not living in the right now. It’s living in what’s going to happen down the road,” Ortega said.

The cash-out refi market is still tiny relative to purchase lending, but every opportunity to help a client is precious.

“It’s a tough gig. A lot of borrowers are reluctant to give up their low mortgage rates,” Ortega said. “But if I can free up their cash flow, the mortgage rate is higher but they have extra money to work with, put it back to the mortgage and get out of debt sooner.” 

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