In a growing number of areas in the US, real estate equity has returned. With rising home values, more and more properties are above water, a situation in which the value of the home is greater than the size of its mortgage.
This increase in equity may put thousands of homeowners in position to pull some cash out of their homes using an FHA cash-out refinance.
The advantage of FHA’s cash-out refinance is that it allows homeowners to trade home equity for cash with a loan of up to 85 percent of their property value. While conventional (non-government) lenders allegedly allow cash-out refinancing to an 85 percent loan-to-value, there is an important distinction: private mortgage insurance is required. Private mortgage insurers do not like cash-out refinance transactions – count on needing at least a 700 FICO and a very solid application to have a shot at approval.
In addition, conventional mortgages often come with risk-based pricing adjustments. Both Fannie Mae and Freddie Mac require them for cash-out refinancing. For example, a borrower with a 679 FICO score wanting an 85 percent cash-out refinance gets hit with an extra 5.25 points in fees! That’s $11,000 on a $200,000 mortgage.
So an FHA cash-out refinance might be a less-expensive way to get money for the stock market.
Just Because You Can Doesn’t Mean You Should
This turn of events has led to speculation that homeowners will now go on an equity binge, taking cash from their homes and investing in Wall Street stocks and bonds.
While home values have been rising across the country, stock prices have been soaring. The stock market has recently set new records. If equity values are increasing, and if savers are getting next to nothing for keeping their money in CDs and savings accounts, then why is it illogical to take real estate equity and invest in the stock market?
One answer is that the stock market is extremely risky. It's true that prices have been rising, but that does not mean even-higher values will be part of the future. As they say on Wall Street, past performance does not guarantee future results.
The perfect example of this is the Nikkei 225 stock exchange index in Japan. At this writing, the Nikkei average is above 13,000 for the first time since 2008. Of course, it still remains below the level attained on December 29, 1989 when the same index stood 38,915.
Closer to home, we can look at real numbers from the FHA. HUD had predicted that as of this time in the fiscal year there would be 492,500 FHA mortgage refinances and that 9.6 percent of these would be cash-out mortgages, loans in which borrowers walked away from closing with a check.
In fact, it isn't happening this way. So far in the fiscal year, there have been 243,778 FHA loan refinances, and of this number only 4.7 percent have been cash-out transactions.
We don't know what borrowers are doing with the cash they take out of their homes with an FHA mortgage refinance. What we do know is that there are a lot fewer FHA mortgages than there used to be, and only about half as many as expected involve cash out refinancing.
Thus, worries about homeowners refinancing and rushing over to get their share of rising stock values seems overblown, if only because not too many people are cashing out in the first place. Instead, the greater trend points toward financial conservatism, debt reduction and the search for lower rates.