Cash-Out Refis Could Trap Many Borrowers

Risky loans were a key player in the leadup to the 2008 housing crisis, and according to a new research brief from the American Enterprise Institute (AEI) and the Center for Responsible Lending (CRL) borrowers should be wary of cash-out refinance mortgages—even those backed by the government—because using your home as an ATM can trap borrowers and worsen their financial stability for years to come. 

These loans, which can sometimes target lower-income borrowers of color, shows that cash-out refinancing in the current high-interest rate environment can lock homeowners into higher monthly payments, raising concerns that that government guarantee policies are promoting irresponsible lending to vulnerable parties. Borrowers with credit scores below 660 constitute an increasing share of FHA and VA cash-out refinance borrowers. 

According to the AEI and CRL cash-out refinances in today’s higher-rate mortgage market can make borrowers worse off financially due to the fact that tens of thousands of extra interest will be tacked onto the original mortgage. 

“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,” AEI said. “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).” 

"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." 

Click here to view the research in its entirety.