Could a Cash Out Refinance Be a Better Solution Than Mortgage Forbearance?

Posted on April 16th, 2020

The current solution for those struggling to make mortgage payments due to COVID-19 is mortgage forbearance.

It allows homeowners to “pause” mortgage payments for anywhere from six to 12 months while their income is reduced or completely nonexistent.

Once it comes to an end, the homeowner must repay the missed payments, either by making a lump sum payment or getting on some kind of repayment plan.

But what about instead of forbearance, the borrower simply executed a cash out refinance and used the proceeds to cover expenses until they got back on track?

This is an interesting idea floated by Urban Institute VP Laurie Goodman and Brookings fellow Aaron Klein.

While taking on more debt doesn’t sound like the most sensible plan when you already can’t make ends meet, homeowners are currently sitting on a mountain of home equity.

During the previous housing crisis, a streamlined refinance program called the Home Affordable Refinance Program (HARP) was implemented to lower monthly mortgage payments for roughly 3.4 million Americans.

It allowed homeowners to refinance even if they didn’t have sufficient equity in their home, or in most cases, negative equity. And they could do so with limited documentation and no home appraisal.

The argument was that it didn’t increase risk to Fannie Mae and Freddie Mac because these homeowners wound up with lower monthly payments, even if they didn’t traditionally qualify for a mortgage refinance.

Homeowners Don’t Have Cash, But They’ve Got Equity

housing market value

Today, we face a different challenge – homeowners don’t have cash on hand to make mortgage payments while their employment is disrupted by the coronavirus epidemic.

However, many homeowners have a ton of home equity, perhaps hundreds of thousands of dollars of it.

Collectively, there’s apparently $19.7 trillion in home equity and $11.1 trillion in household debt (mortgages).

Some $6.88 trillion of that is agency debt, backed by Fannie Mae, Freddie Mac, or Ginnie Mae, which covers FHA loans, VA loans, and USDA loans.

If homeowners could somehow tap into it, and obtain a near record low mortgage rate at the same time, it could be viewed as a win-win.

After all, borrowing cash with an interest rate around 3% on a 30-year term is a pretty good deal, and one that is hard to beat elsewhere.

Goodman and Klein say one of the best ways to stimulate the economy is via refinancing, but point out that there are roadblocks currently in place.

“What is the purpose of the Fed lowering short term rates to zero and buying hundreds of billions of mortgages to lower mortgage interest rates if people cannot functionally access a mortgage?”

A Streamlined Cash Out Refinance Program?

  • Could Fannie and Freddie make it easier to get a cash out refinance
  • By waiving appraisal requirements and reducing documentation requests
  • Might be a better alternative to forbearance for borrowers and loan servicers
  • Default risk would be mitigated if LTV is 80% or less

The researchers have floated the idea of a more lenient cash out mortgage environment, by applying some of the same benefits currently available to rate and term refinances.

This includes appraisal waivers, which are hugely important right now with many homeowners and appraisers told to shelter at home and maintain social distancing.

They do note that a cash out refinance increases risk to the GSEs, but call it “marginal” since the max loan-to-value (LTV) ratio is 80%.

That leaves a healthy cushion of at least 20% in home equity should the borrower default on the mortgage in the future, or be forced to sell the property.

The pair have also called for the expansion of these appraisal waivers to cover all GSE to GSE refinancings, including cross GSE (Fannie to Freddie and Freddie to Fannie) transactions.

“Allowing for more cash out refinancings will allow households to tap into the $19.7 trillion of existing home equity to better weather this economic maelstrom, thereby resulting in fewer people falling behind on their mortgage, and reducing forbearances.”

If they’re able to reduce forbearance requests, it will also help banks and perhaps more importantly, nonbanks, survive the crisis without needing some sort of liquidity backstop.

They also warn that it’s “important to act quickly” because once a borrower receives forbearance they’re no longer eligible for a mortgage refinance.

“Many borrowers may see a cash out refinance, with the opportunity to tap into wealth while locking in the lowest rates in several generations, as preferable to forbearance.”

About the Author: Colin Robertson

Before creating this blog, Colin worked as an account executive for a wholesale mortgage lender in Los Angeles. He has been writing passionately about mortgages for nearly 15 years.


How Does Your Credit Score Compare to Your State’s?

Record unemployment rates, a wild swing in America’s GDP and homeownership rates increasing month over month. Despite these examples of economic volatility of 2020, another surprising number emerged — America has now reached an all-time average high credit score.

Experian’s latest Consumer Credit Review highlights new trends regarding credit. Not only does the credit score landscape change among generational groups and consumer’s location, but it’s clear Americans are focused on paying down specific types of debt, all leading to an overall score improvement.

69% of Americans had a credit score of 670 or higher

This credit score average stands out because only in the year prior was the percentage at 66% and then jumped up three percentage points in one year. The average American credit score from 2020 sits at 710, which also significantly increased from the prior year.

In 2019, the average score for Americans was 703. This level of growth is unusually high compared to observations from the last 10 years, where FICO scores tend to only grow about one percentage point per year. 

[ Read: How to Raise Your Credit Score ]

The increase in credit scores now puts more Americans in FICO’s “good” credit score range. If a credit score lands between 670 to 739, it opens up more borrowing opportunities from lenders, and consumers in this range should qualify for most credit cards and loans. According to Rod Griffin, Senior Director of Consumer Education and Advocacy for Experian, there are promising signs for how consumers are managing their credit histories, despite challenging financial situations due to the pandemic.

“Credit scores have continued to improve, which is a trend we’ve seen over the last ten years or so, reaching an average score of 688.  Lower credit card balances, fewer missed payments and lower credit utilization, or balance-to-limit ratios, have supported this increase in average scores,” adds Griffin.

2019 2020 Change
Average U.S. FICO Credit Score 703 710 + 7 points (1%)
Average U.S. Credit Card Debt $6,194 $5,313 -$879 (14%)
Average U.S. Credit Utilization 28.8% 25.3% -3.5 (12%)

Source: Experian 2020 Consumer Credit Review

Average credit score in each state 

Not only did average credit scores increase overall, but there appear to be trends emerging within specific states. For example, the top states in the country that saw the highest increase in overall credit score were Arizona, Delaware, Idaho, North Carolina and Washington D.C. These states averaged about a 9 or 10 point increase in average score from 2019. 

[ Read: What Is a Good Credit Score Range? ]

On the other hand, North Dakota, South Dakota, Hawaii, Nebraska and Vermont recorded the lowest growth in average credit scores from 2019 to 2020. But what is noteworthy about these states is they already had higher-than-average credit scores to begin with, which means there was less room for an increase to occur. But overall, no matter the location, there is an upward trend in credit scores across America.

In this article

Average credit card debt down 14%   

Credit scores are not the only numbers showing interesting trends. Overall, the U.S. average consumer debt decreased by 14%, even amid an economic downturn. This has a trickle-down effect with credit utilization, which also experienced a decrease of 3.5%. This means not only are Americans paying more towards credit card balances, but the available credit for each individual is loosening up. 

As Americans pay down their credit card balances and decrease their credit utilization, the result is typically an increase in credit scores. Balances and utilization are two major factors used to calculate the FICO credit score.

It might seem odd that in the middle of high unemployment numbers and jobless claims that credit card debt would decrease. But with federal student loan payments and interest accrual on pause from the CARES act of 2020, it appears the debt payoff shifted to credit cards and not student loans.

When you look specifically at federal student loans only, borrowing either stayed the same or increased from 2019 to 2020, depending on the type of loan. Student loans, both federal and private, do show on consumer’s credit reports, but it’s the credit card balances showing the decrease in 2020, not student loans.  

Credit scores improved the most among Millenials  

Similar to how location influences the numbers of increased credit scores, age appears to be a factor as well. When examining the averages, it becomes clear how different the increases in credit scores are among the different generations.

  • Millennials (ages 24-39) increased their average FICO score by +11 points from 2019 to 2020.
  • Gen X (ages 40-55) increased their average FICO score by +10 points.
  • Gen Z (ages 18-23) increasing scores by +7 points.

Even though Baby Boomers (ages 56-74) and The Silent Generation (age 75+) had less of an increase, +5 and +1 respectively, these numbers indicate America as a whole is increasing credit scores overall, no matter the age. 

“Millennials have continued to improve their credit scores. In 2019 they had an average credit score of 647. This rose to 658 in 2020. While still below the average of 688, responsible borrowing habits, including fewer missed payments and lower card balances, are helping Millennials move their credit scores in a positive direction. This trend should encourage Millennials and all consumers to be proactive in protecting and maintaining their credit histories during this time,” explains Griffin.

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Good Financial Cents, and author of the personal finance book Soldier of Finance. Jeff is an Iraqi combat veteran and served 9 years in the Army National Guard. His work is regularly featured in Forbes, Business Insider, and Entrepreneur.