Many homeowners will likely take advantage of increasing property values this year by tapping into the equity of their homes. In fact, the Mortgage Bankers Association forecasts that refinances will account for 32% of all mortgages originated in 2020. Originators, however, should be aware of a recent policy change that could have a major impact on cash-out refinances.
This past September, the U.S. Department of Housing and Urban Development (HUD) lowered the loan-to-value ratio ceiling on Federal Housing Administration (FHA) loans from 85% to 80%. This essentially makes 5% less of a property’s equity available for cash-out refinancing purposes. As a simple example, someone who owns a home valued at $100,000 and who has $50,000 of equity could take out $30,000 in a cash-out refinance under these guidelines. In the past, the same homeowner could have taken out $35,000.
The reason behind the move, HUD explained, is to limit the damage from any future housing collapse. The agency described it as “policy actions designed to reduce the risk associated with cash-out refinance lending.” The move is designed as a safety net to prevent underwater mortgages from occurring in a down economy.
Originators should explain to borrowers what this change could mean for their refinance applications. After all, qualifying a borrower for a mortgage relies heavily on loan and debt ratios. This also is a chance for a mortgage professional to stand out from the pack. Borrowers are seeking knowledgeable experts to help give them sound advice.
The last time HUD amended the loan-to-value (LTV)guideline for cash-out refinances was in 2009 amid the lending crisis that played a major role in the economic recession. The LTV ceiling was lowered from 95% to 85%, where it remained for a decade. During that time, it had become obvious that the housing and real estate industries would never be the same. Banks were closing their doors while foreclosures popped up in neighborhoods across America. The foreclosure crisis was in full force at that time. A CNN article noted that 3 million foreclosure notices were delivered to homeowners throughout 2009. Foreclosure statistics made headlines daily. Homeowners in default had limited options and it was apparent many properties were too highly leveraged. Having a proactive HUD, however, raises the confidence level of real estate sustainability.
The preventive nature of this move establishes an equity cushion should there be another decline in property values. Governing policymakers made this move to protect future real estate ownership and safeguard against underwater mortgage threats. It isn’t known whether a pricing correction will occur this decade, but the added safeguard reduces the threat.
Amended cash-out ceilings have been presented as having a range of benefits. FHA commissioner Brian Montgomery went on record as saying, “This is a prudent measure to make certain that we protect and preserve the home equity borrowers are building for their futures and guard against taxpayer losses from the FHA program.” Equity protection through policymaking is a direct reflection of how hard-hitting the previous housing collapse ended up being.
Underwater mortgages played a major role in the economic recession of the 2000s. The housing sector was negatively impacted much longer than experts predicted. Real estate has a cyclical pricing history and this preventive measure from HUD could help protect future mortgage originations.
Loan-ratio ranges and cash-out ceilings can swing an application between approved and declined statuses.
Chance to distinguish
Low unemployment, interest rate reductions and housing shortages indicate a strong year of refinancing transactions ahead. Homeowners may want use equity to pay off debts or make property improvements. Mortgages are more affordable with today’s low interest rates, fueling the belief that this will be a busy year for lenders and originators.
The Federal Reserve enacted three separate rate cuts last year of 0.25 percentage points. These cuts occurred in July, September and October. The last time the Fed dropped interest rates prior to 2019 was in 2008 during the financial crisis. Interest rate cuts have historically led to an uptick in refinances from homeowners wanting a lower monthly payment.
U.S. homeowners had accumulated about $6.2 trillion in accessible ownership equity as of third-quarter 2019, according to a CNBC article. Accessible equity refers to the equity available to property owners for cash-out purposes. It’s calculated by the difference between existing debt and, with the new HUD guidelines, 80% of the property value. Some property owners will liquidate by selling their property but those who hold may decide to refinance.
Originators may be able to distinguish themselves with an understanding of the new HUD guidelines and other news that greatly weighs on mortgage qualifications. Loan-ratio ranges and cash-out ceilings can swing an application between approved and declined statuses. Clients have the right to receive such information before they fill out an application. When disclosing effective changes, it’s good to reference the actual sources, such as the HUD handbook.
Major industry shifts such as this one should hit the sales-training desk immediately to assure an informed sales approach. Updated sales scripts to reflect the loan-ratio policy change also may earn trust with clients by showing a keen awareness of financial trends. The reduction of the cash-out ceiling is significant and creates a fiduciary responsibility for originators to properly disclose prior to qualification.
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Closing mortgage transactions and earning a commission isn’t an easy job. It requires a team of people on a coordinated timeline to expedite escrows, but that shouldn’t limit an originator’s attention to industry details. The HUD cash-out ceiling reduction is geared toward protecting future homeownership equity. Properly informing mortgage applicants of this change can improve a client’s experience and increase their odds of approval.