The complicated transaction: Using net present value to weigh the costs and benefits of the cash-out refinance

Cash-out refinance transactions present unique challenges for borrowers as they involves a myriad of moving financial variables, making it difficult to evaluate the costs and benefits of the loans. While many states have passed legislation to protect borrowers from loan flipping by “net tangible benefit” requirements, no standard financial analysis has been utilized to effectively weigh the costs and benefits of these transactions. In this paper, we explore the appropriate measurements for “net tangible benefit” using simulated cash-out refinances as well as a unique dataset of subprime loans containing information not typically accessible to researchers. Our findings illustrate the complexity and potential pitfalls of these transactions, and suggest that a formal cost-benefit analysis for cash-out refinances should be considered as part of the larger mortgage reform currently underway.