Cash-out refi- nances have varying levels of risk. Key
determinants are bor-
rower motivation, amount
of proceeds relative to
equity, loan amount, and
affordability. Ideally, moti-
vation is explained in an
unedited and sufficiently
detailed letter of explana-
tion. The higher the proceeds, the more critical the
credibility of the letter.
The following list runs from higher to
lower risk, more or less:
Cash-out to extract maximum equity: In a depreciating
housing market, when a business is prioritized over a
borrower's home or when the borrower is desperate
for any reason, default has higher potential. The trigger may be economic or personal circumstances. Risk
indicators are insistence on maximum cash proceeds,
cancellation if proceeds are reduced, and an unconvincing motivation letter, such as home improvement
when improvements aren't necessary or when proceeds don't correlate with the cost of improvements.
Repetitive debt consolidation: Borrowers who refinance
periodically to start off with a clean slate rationalize
that mortgage rates are substantially lower than credit
card rates. Reduced payments also are a magnet for
consumers with high outstanding balances. Recur-
ring conversion of short-term unsecured debt into
long-term secured debt is poor financial management.
When there is insufficient equity to refinance because
of serial refinances or down-trending property values,
the merry-go-round grinds to a stop. Adjusted spend-
ing habits aren't assured even when circumstances
don't allow another refinance. The remaining solutions
are foreclosure or bankruptcy, which can be as costly
to the lender as a foreclosure.
Speculative investment: A speculative investment is
any venture verbally guaranteed to be profitable.
The borrower should be encouraged to research the
investment thoroughly and discuss the probability
of profitability with a CPA, financial advisor, or other
impartial third party. On an ill-advised investment, loan
denial may be later appreciated by the borrowers. Of
course, unproven investment income cannot be used
Cash-out to be generous: Generosity is an admirable
trait, but less so when it requires tapping into equity
for someone else's down payment, student loan debt,
or dream wedding. Even when low interest rates
allow for inexpensive borrowing, the increased payment amounts and term of repayment may negatively
impact the borrower when earnings have decreased.
Well-meaning is not always smart.
If cash-out is for college tuition, at least one child
should be of appropriate age for college. Asking for
copies of the admission letter or transcripts is excessive but if there aren’t any dependents, feel free to
take issue with whoever took the loan application. If
tax returns indicate no dependents, be wary of the
The Cash Out
By Anne Elliott UNDERWRITING