AEI Housing Center and CRL warn of risks similar to lead-up to 2008 housing crisis
WASHINGTON, DC – 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 – that can provide a quick influx of cash but leave the borrower in a trap that can worsen their financial stability for years to come.
A new research brief from the American Enterprise Institute (AEI) Housing Center and the Center for Responsible Lending (CRL) shows that cash-out refinancing in the current high-interest rate environment can lock homeowners into higher monthly payments and raises concerns that government guarantee policies are promoting the use of “the house as an ATM” by lower-wealth, cash-constrained buyers. Borrowers with credit scores below 660 constitute an increasing share of FHA and VA cash-out refinance borrowers.
Joint AEI Housing Center and CRL analysis of data from proprietary and public datasets illuminates what these lenders’ advertisements don’t reveal: cash-out refinances in today’s higher-rate mortgage market can make borrowers worse off financially because they come with tens of thousands of dollars of extra interest because they substantially increase the interest rate on the borrower's existing mortgage balance. Many lenders offer cash-out refinance loans to give consumers a quick infusion of cash to consolidate and pay off debt, meet everyday living expenses, or make repairs. However, the AEI Housing Center and CRL warn that many cash-out refinancing offers, including for government-guaranteed mortgages, may pose risks for borrowers, including:
- Monthly payments up to 37% higher from refinancing the old mortgage into a higher rate loan
- Tens of thousands of dollars of additional interest paid over a typical mortgage holding period (based on a 30-year fixed rate loan at about 6.5% today, vs 3%-4.5% in 2015)
CRL and AEI found that at the current rate of about 13,000 FHA and VA cash-out refinances a month, about 160,000 homeowners over the next 12 months could be saddled with higher mortgage costs that can negatively impact their financial health in years ahead. Regulators should take immediate actions to keep these homeowners from incurring billions of dollars of extra interest and lost home equity.
Both organizations say borrowers should be informed of these potential pitfalls and search for safer, lower-cost alternatives, such as fixed-rate home equity loans (HEL) or an adjustable-rate Home Equity Line of Credit (HELOC). “Low wealth, lower credit score and veteran homeowners deserve better alternatives for borrowing cash through accessing their home equity in today’s high interest rate environment without eroding their long-term financial health,” said Mike Calhoun, president of CRL. “Consumers also should have access to clear and reliable information about the financial consequences of cash-out refinancing.”
“A broader availability of HELs and HELOCs 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,” said 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.”
A cash-out refinance allows a homeowner to receive cash from increased equity in their homes due to price appreciation or paid-down mortgage principal. Borrowers take out a new, larger loan at current market rates to pay off their existing mortgage and receive the difference in cash. Homeowners who obtained a 30-year loan from 2015 to 2021 could have an interest rate on their original mortgage ranging from around 3 percent to about 4.5 percent. Check out AEI’s helpful cash-out refinance explainer video.
According to AEI Housing Center and CRL, borrowers with FHA and VA mortgages, typically minority, low-wealth and veteran homeowners, constitute a growing share of cash-out refinance borrowers. These borrowers can be liquidity-challenged in today’s high inflation environment.
Over the past two years, the composition of FHA and VA cash-out refinance borrowers has shifted toward lower FICO score borrowers. During that period, the average FICO score of borrowers obtaining an FHA cash-out refinance loan dropped from 671 to 637. The average FICO score of borrowers obtaining a VA cash-out refinance loan fell from 730 to 675.
Lenders also appear to be more active in neighborhoods with high proportions of Black residents, continuing a pattern of unsustainable racially focused lending – reminiscent of the last housing crash – that perpetuates the racial wealth gap and impedes the transfer of intergenerational wealth in these communities.
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