Don’t be tempted by offers of cash on your mortgage. These are the risks.
People across the United States are increasingly seeking to borrow against their home equity, increasing the nation’s mortgage debt to banks and putting their ownership at risk in case of a recession.
A new study indicates that 76.6 percent of the mortgage refinancing currently underway includes the idea of getting cash. This type of refinancing, known as cash-out refinancing, was one of the causes of the Great Recession in 2008.
Florida ranks seventh among the states for this type of loan, according to the study by Refi Guide, a website that offers news reports and recommendations from experts about mortgage loans.
The study, based on data from mortgage giant Freddie Mac for 1990-2019, showed that cash-out mortgages represented 90 percent of the loans in the years before the Great Recession. By 2012, the percentage had fallen to 12 percent, but by 2018 it had exploded back to 80 percent.
Mortgage experts agree that it is common and can be even advantageous for people to take advantage of lower interest rates. For example, if you have a 6 percent mortgage it would be a good idea to refinance now because interest rates are lower. It could also be a good idea if you have a variable interest mortgage to refinance at a fixed rate.
But a cash-out deal that allows homeowners to obtain cash using their property as collateral carries a series of risks that makes experts recommend avoiding them.
“That should not be done, because you’re using your home like a savings account,” said Leo González, mortgage officer at CMG Financial, based in South Florida.
There are many reasons for taking a cash-out loan, including using the money to pay off credit card debt at high interest rates, buying a new car, paying for expensive trips or student loans, weddings and home renovations.
The loans are based on the value of the homes compared to the outstanding mortgages, known as equity.
By borrowing cash against the equity, homeowners can increase their monthly payments and put themselves at risk if they lose their jobs.
A recession usually leads to an increase in unemployment as well as a drop in real estate sales and values, which would make it even more difficult to sell a property for the sum owed to the bank.
That was one of the reasons why many people opted to stop paying their mortgages and go into foreclosure during the 2008 recession.
The Refi Guide report showed that in Florida, 1.2 percent of the cash-out refinancing is designed to get cash, meaning that many people would be vulnerable in case of an economic crisis.
Alaska heads the list of states with those types of refinancing at 3.7 percent, followed by Nevada at 1.7 percent. Florida, Idaho, Texas, Utah and Arizona are tied at 1.2 percent.
The states with the lowest percentages are Wisconsin (0.4%), Connecticut (0.5%), Vermont (0.6%), Iowa (0.6%), Hawaii (0.6%), Maryland (0.6%), Illinois (0.6%), Massachusetts (0.6%), Virginia (0.6%) and Washington D.C. (0.6%).
Gonzalez noted that if the homeowners’ priority is to pay off the mortgage, so they can then pay only for the property taxes and insurance, then every new loan on the property pushes that goal further into the future.
And if a family loses its home because it cannot pay the mortgage, it will have to rent a new dwelling – not a good prospect at a time when Florida faces a rental crisis as demand far outstrips supply and prices soar.
For the experts, caution is the word when it comes time to borrowing, because the idea is to produce more than what is owed.
The trend to obtain cash-out refinancing has increased in the past five years, just as it did in 2006, two years before the Great Recession. That’s why the alert sounded by the study could shift the winds in a positive direction.
This story was originally published November 5, 2019 at 4:30 AM.
