- Posted by: steve
- Category: cash out, mortgage articles, refinance
Wondering if you can get cash back when you refinance? We’re covering all the bases in our ultimate cash out mortgage refinance guide.
Housing values across the country continue to increase.
That means that tapping into home equity while refinancing is becoming more of a possibility for many homeowners.
But there are different ways to approach refinancing. One option is a mortgage refinance. Another is cash out mortgage refinancing.
If you’re a homeowner in need of cash, you may want to consider cash out mortgage financing.
So what’s the difference between a mortgage refinance and cash out mortgage financing?
When a homeowner gets a new loan to replace the current mortgage loan, that’s a mortgage refinance. This is usually done for the purpose of getting a lower interest rate.
But with cash out mortgage financing, also known as a cash-out refinance, the homeowner refinances their mortgage for more than the current outstanding balance. They keep the cash difference between the old and new loans.
For example, say you want $30,000 to start your dream business. At the moment, you owe $70,000 on a $180,000 house.
You can refinance the mortgage at $100,000 and use the extra $30,000 in equity you pulled out to start up your business. You may even get a lower rate and a lower payment on the new mortgage.
Cashing out should be done with serious consideration though. Speak to mortgage experts first.
During the last recession, many borrowers enticed by this cash option either lost their homes or ended up buried in their mortgages.
Are there restrictions on how to use the cash?
The short answer is, not really.
With cash out mortgage financing, you have relative freedom with how you use the cash. You might be paying off a student loan debt or updating your kitchen.
Even though you have that freedom, you’ll want to keep in mind that some uses for the cash make more financial sense than others.
For instance, if you hold credit card debt at a high-interest rate, you may go with the cash-out refinance option to pay it off. Chances are, the interest on your new loan will be much less than that of your credit card.
Just be sure that the all-in costs, including the closing costs for the cash out, refinance, work out in your favor.
When you’re able to pay down those maxed-out credit cards, you boost your credit score. You’ll also get a tax benefit from moving the credit card debt to mortgage debt because you can deduct mortgage interest on your taxes.
Another good idea?
Use the cash to take care of home improvements. Whether it’s putting in a new kitchen or updating your electrical wiring, improvements will increase your home’s value down the road.
Obviously paying off debts and doing home improvements are smarter choices than taking the cash and hoping for a lucky streak at the casino. But either way, using this cash is risky.
If you don’t repay the new mortgage loan amount, you run the risk of losing your home.
As with anything in life, there are both benefits and drawbacks to the cash-out refinance option.
The benefits of cash out mortgage financing
1. Take care of big expenses.
If you need to access money to pay off big bills like medical expenses, home improvements, college tuition or expenses for funding for your new business, a cash-out refinance might be just what you need.
Cash out mortgage financing usually offers a more attractive interest rate than those on unsecured personal loans, student loans or credit cards you may be tempted to use to pay off those big bills.
2. Improve your debt profile.
Another popular cash out refinance is using it to reduce or consolidate credit card debt. The weighted average interest rate on a borrower’s credit cards must be taken into consideration to determine whether moving the debt to a mortgage will provide a lower rate.
As another, for instance, let’s say a borrower is paying 14% on $62,000 on 4 credit cards. If that can be moved to the mortgage at a lower rate, the borrower will be paying less to borrow the same amount of money.
Plus, that debt can be written off on your taxes.
3. Secure a more stable rate.
As we mentioned above, some borrowers choose to do cash out mortgage financing for home improvement projects because they want a fixed interest rate instead of an adjustable rate that comes with a home equity line of credit (HELOC).
With a HELOC, borrowers will pay prime plus 2 or 3 percentage points which is only great if you can pay it off before those short-term rates go up.
But if you can’t pay if off before that time, then the stable rate that comes with the cash out mortgage financing is a better option.
The drawbacks of a cash out refinance
1. The terms aren’t as good.
Yeah, you may very well get a lower interest rate with a cash out refinance than your current mortgage, your rate will be higher than a regular refinance at market rate.
Even if you have the greatest credit score ever, with cash outs you’re always going to pay a little more – usually an eighth of a percentage point higher – than the market.
2. The process is involved and sometimes expensive.
You’ll be doing a lot of gathering.
Just like you did when you first got your home loan. So be prepared to show up with at least the past two years of tax returns and W-2 forms; a month’s worth of pay stubs; the two most recent bank statements.
There might be more too.
Keep in mind too that some of that cash from your refinance will have to go toward paying closing costs. Depending on any number of factors, this figure can fall anywhere from hundreds to thousands of dollars.
3. Your home is at more risk.
While home values are high, it’s easy to think that the money will always be there. But the reality is housing values do go down.
So if you take out equity now, it puts you at greater risk down the road of owing more than your home is worth when housing values go down.
And default rates on a cash-out refinance are usually higher than those on regular refinances.
Does everyone qualify for cash out mortgage financing?
If you’re feeling like cash out mortgage financing is for you, there are some requirements.
The first big factor is your loan-to-value (LTV) ratio.
The loan-to-value ratio is your outstanding mortgage debt represented as a percentage of the home’s current market value.
The formula is Mortgage amount owed / Appraised value.
For example, if you owe $65,000 on a house that’s valued at $100,000, then the loan-to-value ratio would be 65%.
The LTV ratio requirement for cash out mortgage financing is more conservative than for a regular refinance.
On home loans that are $500,000 or less, the maximum loan-to-value ratio is 80%. For loans over $500,000, it drops to 70%.
The next factor is your credit score.
Generally speaking, the higher your credit score, the better the interest rate on your cash out refinance.
If your score is 700 or higher, you’ll be in good shape.
If it’s under 700, you’ll have to pay a half-point to three-quarters of a point more. And if your credit needs some work, you’re looking a potentially expensive situation.
The third factor is an appraisal on your home.
Getting a low appraisal isn’t good for any refinance situation – cash out refinance included.
In order to get the best appraisal possible, take care of any small repairs or maintenance on your home before you set up an appointment with an appraiser.
And once the appraiser comes, you’ll want to be there when he or she arrives so you can point out any improvements that could go missed.
An appraiser could see that your furnace is in good shape. But if you’re able to add that the furnace was just installed, then the inspector can note that and this can help increase the value of your house.
What it comes down to for cash out mortgage financing.
So here’s the nitty gritty.
Cash out mortgage financing is a good option when three factors are in play:
- You’re getting the best possible interest rate.
- You’ll be able to pay back the new loan easily and quickly.
- You’re going to use the cash for something worthwhile like a home improvement or paying down a high-interest debt.
But as we said before, this is a risky option.
Remember that if you don’t pay off this loan in full and on time, you could lose your home.
You should also not choose cash out mortgage financing if the interest rate on the new loan isn’t better than your current home loan, and/or you’re worried that you’ll have trouble paying back the loan.
And by all means, do NOT go this route if you plan to use the cash to go on a wild shopping spree or to take a weekend in Paris.
It’s hardly worth risking your house.
If you have had any experience with cash out mortgage financing, be it great or awful or anything in between, we’d love for you to share your experience so that we can help others get the best refinancing experience.