With a cash-out refinance you can use the equity in your home to get cash back.
But when are cash out refinances a good idea? And who qualifies?
We will answer these questions and more in this article.
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What is a cash-out refinance?
A cash-out refinance replaces your existing mortgage. Plus gives you cash back up to 80% of the value of the property.
In order to qualify for a cash-out refi you will need to have at least a 30% equity stake in the property.
The new loan can be for up to 80% LTV. The difference can be given to you as cash.
For example: Your home is worth $300,000 and your mortgage balance is $150,000.
The LTV ratio is 50%. You would be able to get $90,000 cash back with a total loan balance of $240,000, or 80% LTV.
When is a cash-out refinance a good idea?
Usually a cash-out refinance is a good idea if you plan on using the cash you receive to reinvest into the home. Making upgrades or repairs that can increase the value of your home are a great investment.
Many people use a cash back refinance to pay off debt or to make large purchases, but this can back-fire.
If you pay off credit card debt using a cash-out refi, you are turning that unsecured debt into debt that’s secured by your home.
If anything were to happen and you cannot afford to pay the payment, you now could possibly lose your home.
While if a financial hardship were to happen and you couldn’t pay your credit cards your home would be safe.
You can use the money however you wish. You can use the money received from a cash-out refinance to buy an investment property.
Cash-out Refinance Pros and Cons
- Get cash at a lower rate than other types of loans
- Pay off student loans or other types of debts
- Pay off high interest credit cards
- Renovate and make home repairs
- Payments are tax deductible
- Spend cash as you please
- One mortgage payment
- Take advantage of lower interest rates that occur in the housing market
- Closing costs are as much as a regular mortgage
- Lose equity in your home
- Home at a greater risk
- Less favorable loan terms
Why people like them..
Since you now owe less on your home, the new mortgage payment may be considerably less than the one you are paying now.
As a bonus, you get additional money on top of repaying the first loan. You can use this money any way you choose, whether to remodel, pay off credit card debt or even take a vacation.
Cash-out refinance loans allow you to access the equity in your home by refinancing the entire loan.
This is different from a home equity loan, which is another loan in addition to your first mortgage.
Cash-out Refinance vs HELOC and Home Equity Loans
HELOC, short for home equity line of credit and home equity loans are a second mortgage. The second lender wives you a loan and secures that loan with the equity you have in the home.
A HELOC works like a credit card, giving you an account you can withdraw money from whenever you need it. You pay back the loan monthly and pay interest only on the amount of money you withdraw.
With a cash-out refinance the lender writes a new mortgage to payoff the original loan plus gives you cash up to 80% LTV.
Instead of having two loan payments each money, you have just one. The cash is given upfront and usually has a better rate than a HELOC.
Cash Out Refinance Tax Implications
One of the benefits of a mortgage is that the interest is tax deductible. When you choose to do a cash out refinance the same applies.
The interest paid on the cash received is also tax deductible. You’ll have only one monthly mortgage payment to make.
Credit Score Requirements
Because the lender is refinancing your entire mortgage they are a first position lean holder.
As opposed to a HELOC where the lender is the second lien holder, meaning if you go though foreclosure the first lender is entitled to receive all their money backhand the rest goes to the second lean holder.
This makes a cash out refi much less risky than a HELOC. If you have bad credit then a cash out refinance is a more viable option than a home equity loan or HELOC.
Typically you will need a 620-640 credit score for cash out refinances. Home equity loans generally require a 680 or higher credit score.
Lower your interest rate
There are times when cash-out loans can help you get the cash you need while reducing your monthly payments.
For example, if your first mortgage was made at a high interest rate, a new loan with a lower interest rate can cut the overall cost of the loan enough that even taking out cash, the overall amount owed can decrease.
With interest rates still at all time lows, now is a great time to refinance your home and lock in a new low rate.
Who Can Get a Cash-Out Refinance Loan?
Qualifying for a cash-out refinance loan is similar to qualifying for an initial mortgage. Your lender will consider the loan-to-value ratio, your credit score and the appraised value of the home when deciding whether to issue the loan.
The loan-to-value ratio is figured by dividing the mortgage amount owed by the appraised value. Typically, that figure must be less than 80%.
You need a good credit rating to get the best interest rates, especially if your loan-to-value ratio is on the high end.
You can also influence the appraised value is you are present during the appraisal and point out any improvements that have been made recently.
Cash-out refinance loan requirements
- 640 credit score
- No recent late payments (No late past 12 months)
- At least a 70% LTV or lower
- 2 years of provable income
- 2 years of tax returns
Cash out refinances make up a third of all refinances. This number is way down from 89% in 2006.
Chart curtesy of BankRate.com
Cash-out refinances are a great way to get cash back using the built up equity in your home. You can use this cash for anything you like. But be careful with what you spend the money on.
Paying off debt turns unsecured debts like credit cards and student loans into secured debt with your home as collateral.
Using cash-out refis to make home improvements or repairs that will increase the value of your property is recommended.
Whatever you decide to do make sure you are fully informed of the costs and options available to you.
Speaking to an experience loan officer who can help guide you through the process is always recommended. Like with any loan you should compare multiple lenders.
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