The Department of Housing and Urban Development (HUD) and Ginnie Mae are tightening loan-to-value (LTV) ratio requirements for cash-out refinances.
A cash-out refinance allows a homeowner to replace their old mortgage with a new one, receiving part of the mortgage proceeds as cash to complete home improvements, pay for college or pursue other opportunities. The cash represents the home equity gained under the previous mortgage. It’s a nice idea, because the interest rate on a cash-out refinance is much lower than a personal loan. But it’s also very risky, because defaulting means foreclosure — the loss of the family home.
The mortgages affected include cash-out refinances insured or guaranteed by the:
- Federal Housing Administration (FHA); and
- Veterans Administration (VA).
The last time the FHA changed their equity rules was in 2009 when the minimum equity requirement was increased from 5% to 15%. Starting September 1, 2019, cash-out refinances on FHA mortgages will need a minimum of 20% equity. In other words, qualifying mortgages will have a maximum LTV of 80%. [See HUD Mortgagee Letter 2019-11]
VA-guaranteed mortgages are also seeing stricter LTV standards. Beginning November 1, 2019, Ginnie Mae will set a maximum LTV limit of 90% for all VA-guaranteed cash-out refinance mortgages, except those for permanent construction loans. [See All Participant Memorandum 19-05]
Refinances in 2019-2020
When the LTV requirements last changed in 2009, it was in reaction to the destabilizing housing market. It was noted at the time that mortgages secured by homes with cash-out refinances were more likely to default and reach foreclosure. The less skin in the game, the less likely the homeowner was to continue paying their mortgage when their home was underwater.
In 2019, HUD claims the change is a preemptive measure, to “stay ahead of any potential future shift in the housing market.” Put another way, HUD officials see the signs that point to a housing slowdown and are making an effort to decrease the number of refinancers who have less skin in the game.
Refinances become more common when interest rates drop, a situation we find ourselves in during 2019. In the first half of the year, the number of refinances rose as average mortgage interest rates decreased. Expect refinances to remain strong for the next one-to-two years as interest rates remain low.
However, cash-out refinances will see a slightly different trend, as cash-out refinances remain popular only so long as home equity is high. With these stricter LTV requirements, homeowners will need even higher LTVs to access their equity. As California home prices turn down in 2019-2020, the number of negative equity homes will rise and removing more homes from qualifying at the stricter LTV standards.
Real estate professionals with their clients’ best interests in mind will caution them from pursuing a cash-out refinance in 2019-2020. Declining home values in the coming months will put refinancers in poor positions, and they may very well find themselves underwater.