FOR THOUSANDS of American homeowners, the question of the week is not whether to refinance their mortgage, but whether to pull out extra cash when they do refinance.
Put another way: Mortgage rate decreases since the summer have rendered the refinance question a no-brainer for lots of people.
If you can cut your fixed mortgage rate from the mid- or upper-7 percent range to the mid-6 percent range at a cost you can recoup in 12 months to 18 months, then the answer is virtually always yes to a refinance.
But what happens to the equation when you -- like many other homeowners -- are tempted to take out extra money, beyond your current total mortgage debt, to use for some nonhousing purpose?
Say you have a $200,000 home with an existing $140,000 first mortgage at 8 percent. You know you can save a bundle by refinancing into a new 30-year $140,000 mortgage at 6.75 percent.
But what if you want to pull more cash out of the transaction -- say another $20,000 to $30,000 to help pay for the kids' tuition, or to invest, or to buy a new car? Are you going to have to pay more? The answer is not so simple.
The automated underwriting systems widely in use and connected to mortgage industry giants Fannie Mae and Freddie Mac will evaluate -- and price -- you differently when you want to pull out extra cash. Ditto for most large mortgage companies who sell their loans into pools that become bonds on Wall Street.
But some lenders -- up to a point -- won't charge you extra, or hold it a gainst you, if you want some more cash in your pocket. Here's a quick overview of what to expect in the little-charted financial territory known as cash-out refinances:
Both Fannie Mae and Freddie Mac are happy to buy mortgages involving cash-out refinances. But executives at both companies say that cashing-out increases your statistical probability of default down the road.
As a result, you may have to pay a bit more on the rate from the lender who sells your loan to either Fannie or Freddie.
For both companies, a key factor is your "loan-to-value" ratio or LTV. Once you push your LTV over 75 percent through a cash-out, you're highly likely to be asked to pay a premium on your rate.
How much of a premium depends on contractual arrangements with individual lenders and on your overall risk profile, according to both companies. But mortgage industry sources say one-quarter of 1 percent extra on the rate would be a typical surcharge.
In the $200,000 example above, once you took your loan above $150,000 (75 percent LTV) to $160,000 (80 percent LTV), you'd probably trigger an extra quarter of a percentage point on the rate. Instead of a 6.75 percent quote from your lender, in other words, you'd get 7 percent.
The rationale? In the words of Fannie Mae Vice President Frank DeMarais, "It's a fairly well-documented risk factor" that when people pull out mortgage cash for nonmortgage purposes, the likelihood of default increases.
DeMarais also pointed out that in most refinancings, "there's a push on the appraisal" -- subtle or unsubtle pressure on the appraiser to deliver a valuation that supports the amount needed to close the loan.
The potential risk from such a "push" on the appraisal is heightened further when the refinanced mortgage balance is larger than the balance before the refinance. Was that $200,000 house in the example really a $200,000 house, or was it a bit of a stretch from its true market resale value of $190,000-$195,000? The higher the debt against that property, the higher the risk of loss -- and the size of the loss -- to the lender in the event of a foreclosure.
Freddie Mac's automated underwriting system approaches cash-out refinances much the same as Fannie's. But a Freddie Mac spokeswoman, Sharon McHale, emphasized that the electronic system's complex evaluations of each loan application "could very well" end up charging a borrower little or nothing extra for a modest cash-out above the 75 percent LTV guideline.
People with particularly high credit scores, for example, said McHale, might pay zero extra on a cash-out.
What about cash-out refi pricing in the so-called "jumbo" loan market?
According to Michael Covino, president and chief executive of LuxMac, a New York-based jumbo mortgage lender, the range in rate premiums for big loans in the $500,000 to $750,000 and up category typically is one-quarter to three-quarters of a percentage point, depending on the loan-to-value ratio and the amount being cashed out above the previous balance. The lower the LTV, the smaller the cash-out, and the more sterling the credit profile, the lower the premium.
Should you take cash out when you refinance? If your LTV and credit scores qualify you for cash-out at a low premium, and you have a good use for the money -- like paying down high-rate consumer debt -- why not?
Kenneth R. Harney is a syndicated columnist. Send letters care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071.
Pub Date: 10/11/98