Cash-out Refinancing: Lower Volume, Less Risk This Time Around

By Arthur Jobe Housing Affordability, Mortgage Finance

In 2017 and 2018, the home mortgage industry witnessed a resurgence in the cash-out share of refinance loans, similar to the spike observed just before the Great Recession. However, the credit quality, dollar volume and borrower characteristics of these loans could mean that there is less cause for concern this time round.

Lower Volume of Cash-Outs Refinance Loans Today

As covered in a separate blog [2], the recent increase in the share of cash-out refinance loans is not a result of an increase in cash-out originations, but the result of a decrease in interest rate or term reduction originations. When interest rates increased in 2017, the number of borrowers successfully seeking an interest rate or term reduction loan dropped by nearly 50 percent while the volume of cash-loans decreased by just over 8 percent, causing the share of cash-out loans to spike despite the decrease in volume.[1]

Volume is, by far, the largest differentiator between the spike over the past two years and the one between 2004 and 2006. CoreLogic TrueStandings data shows that cash-out origination volume has fallen sharply since 2005. Further, total volume of cash-out loans between 2015 and 2018 was roughly one-quarter of the volume originated between 2003 and 2006.

Outstanding Loan Count

With the sharp decline in yearly cash-out originations since 2005, the count of outstanding loans eventually fell to less than 80 percent of the stock in 2008[3] (Figure 1), reducing lender and investor portfolio exposure to cash-out mortgages.

Better Cash-Out Credit Quality This Time Round

When measured by the "3 C's" of mortgage underwriting – credit worthiness, collateral value and capacity to pay – the quality of originations in the last few years has improved since before the Great Recession. The average first-lien loan-to-value ratio has declined, and the average debt-to-income ratio for cash-out borrowers is roughly the same. However, most notably, stronger average credit scores of cash-out borrowers in 2017 and 2018 suggest lower default risk now than in 2006. According to CoreLogic Servicing data, the weighted average FICO score for loans originated between 2017 and 2018 is roughly 729, compared to 678 for loans originated between 2004 and 2006. Further, the average first-lien loan-to-value ratio is about 67, compared to 70 between 2004 and 2006. The earlier period also had widespread use of second liens, raising the combined first- and second-lien loan-to-value even higher than today. 

Credit Worthiness

Recent cash-out borrowers have also exhibited less risky behavior, as seen by the decrease in repeat cash-out borrowers. At the end of 2008, 1.9 million households, or 28 percent of the 6.9 million households with an active cash-out mortgage, had previously borrowed with a cash-out loan. By September 2018, the number of repeat cash-out households had dropped to 1.4 million, or 26 percent, of 5.4 million. Repeat cash-out borrowers also waited longer before refinancing. A comparison of those households in 2018 to those a decade earlier reveals that recent borrowers waited an additional year prior to refinancing on average. Looking back to 2006, the average time between consecutive refinances was less than two years for those households with either two or three cash-out loans in ownership history. Since 2006, the average years between loans for that group has steadily grown to 3.2 years (Figure 3) [3].

Years Between Consecutive Cash Out Refinance

The recent jump in the share of cash-out refinance loans may be alarming, as it is similar to the climb that peaked in 2006; however, the volume of cash-out loans has been much lower in recent years and loans appear to be less risky when considering credit scores and evaluating serial cash-out refinance borrowers. This resurgence is not the result of an increase in exposure, but rather a natural byproduct of the decline in rate and term reduction refinances resulting from a combination of rising interest rates and increasing home-price growth.

[1] Origination volume is based on CoreLogic TrueStandings Servicing data

[2] Blog Reconciling the Rise in Cash-Out Share to the Decrease in Volume

[3] Based on identifiable cash-out refinance mortgages in CoreLogic Public Records data.

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