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 is a new loan that replaces your current mortgage with a higher balance. The difference in the original balance and the new loan amount will be given to the borrower as cash.
Example: If you have a $200,000 home and your current mortgage balance is $100,000, or 50% LTV. You can get up to $160,000, 80% LTV and put $60,000 cash into your pocket.
In order to qualify for you will need to have at least a 30% equity stake in the property. The maximum loan-to-value ratio is 80%.
Reasons Homeowners use Cash-Out Refinancing
- Making upgrades or repairs that can increase the value of your home
- Pay off high interest debt or consolidate your debt
- Re-invest the funds into the stock market or real estate
- Make necessary purchases like a car or other large expense
- Lower interest rate and mortgage payment by resetting the loan term
Be Careful Using the Funds to Pay off Unsecured Debt
If you pay off credit card debt with the funds from a cash-out refinance, you are turning that unsecured debt into debt that is now secured by your home.
Usually your monthly mortgage payment will increase when you refinance your mortgage. If you were to face a financial hardship and are unable to make the payments you could lose your home to foreclosure.
Using the funds for anything expect making repairs or upgrades to the home is very risky and not recommended.
As an example: Let’s say Tim has $45,000 in credit card debt. He decides to refinance his house to take out $45,000 to pay off his debt. Now his mortgage payment is higher than he is used to. Time loses his job and can no longer afford his mortgage payments and he loses his home.
If Tim would have not refinanced his home, when he lost his job he could stop paying his credit cards and try to come up with the mortgage payments. He keeps his home, but his credit score drops and he owes the credit cards companies. They cannot take his home, the worst thing the creditors can do is file a lawsuit.
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 refinancing allows 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
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 mortgage payments each money, you have just one.
The cash is given upfront and usually has a better rate than a HELOC.
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 refinancing 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 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 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 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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Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.