What is Cash Out Refinance?

13 Jul 2020

This article summarises about a cash-out refinance in detail. This is the refinancing option of a current mortgage loan, where the new mortgage loan is for a higher amount than the existing mortgage loan, and the borrower gets the difference between the two loans in cash. Basically, homeowners do cash-out refinances so they can turn some of the equity they’ve built up in their home into cash. Significantly if you have an amount of equity built up in your home and would like to convert that equity into actual money you can use, a cash-out refinance may make sense for you. 

 For example, let’s draw an instance :

 Let us say you own a $400,000 house and still owe $200,000 on the current mortgage. This indicates you have built up $200,000 in equity. Now you want to take out $40,000 in cash, this amount would be added to the principal of your new home loan. In this illustration, the principal on your new mortgage after the cash out refinance would be $240,000.

What you need to Understand? 

It works by replacing your current mortgage with a new one that has a higher balance. You are refinancing for more than you owe. And, the difference between the two loans is then distributed as cash to the borrower. Cash out may not be for everyone, but you may be surprised by your eligibility. To understand better let’s discuss the key features while considering the Cash out Refinance as an option.

Key features of Cash-Out Refinance 

Like other mortgages, a cash-out refinance is a loan stapled by a sector of real estate, with respect to different requirements and limitations. The most important factors considered in a cash-out refinance mortgage application are as follows :

Loan-to-value ratio:

There are strict limits on the amount of money you can receive in any cash-out refinance.The loan may not exceed a maximum loan-to-value ratio. That means your total home debt can't exceed a certain percentage of the value of your home. You will need equity in the home before you can take cash out. Basically , the standard LTV is 85% of your mortgage equity based on the current trend. This is a general industry standard adopted by lenders following the housing crisis of 2008. It is worth noting that maximum LTV limits were not written in stone, and are ultimately subject to the discretion of the individual lender. Few banks increase LTV limits when the loan is used for home improvement or home appreciation.

 Debt-to-income ratio:

Finally, it is worth noting that by taking advantage of a cash-out refinance you are essentially extending the life of your existing mortgage. Nevertheless, you are doing so at new rates and with new agreed  conditions of repayment. Ideally, these should be an improvement over those associated with your current mortgage. Although in a few cases it can be favorable to bump up the interest rates on your mortgage if you will be using the cash-out funds to pay down higher interest consumer debt. Still, it is necessary to understand that you are effectively taking out a new mortgage, and while you are receiving a cash payout in the bargain you are also taking on a new loan burden. Never forget that you are using your property as collateral, and you always run the risk of losing your home or landing yourself in a negative equity position where you owe more than the house is worth. Besides, You must show the lender, usually via tax returns, a schedule of debts and pay stubs, that you can afford to make the monthly payments.

Credit score:

 All borrowers named on the loan must have a credit score that meets the minimum for the loan program and lender. You need a good credit rating to get the best interest rates, especially if your loan-to-value ratio is on the high end. Typically you will need a 620-640 credit score for cash-out refinances.

Closing Costs:

 Ideally, there will be closing costs associated with a cash-out refinancing transaction. Typically, these are deducted from the amount you receive at closing, though in some circumstances lenders will fold any fees and charges into the principle of the new loan. Points are treated as an upfront interest payment. 

Where can I use this cash?

Cash can be used in any way it is all yours. Many people use it to pay down high-interest credit card debt. Even though you will still owe the same amount of total debt when all is said and done, you can save a lot in monthly interest payments. You may also get the benefit of deducting these interest payments from your taxes, whereas your credit card debt is not tax-deductible . In this situation, your lender will most likely pay your previous lenders directly at the time of your closing.

Alternatively, some people use the cash for a major purchase or expense if financing is not available or is more expensive than the rate on a mortgage. In this situation, your lender may give you your cash directly to use at your discretion. Few advantages for cash-out refinancing are mentioned below:

Advantages:

  • Pay off debt, you can save thousands in interest when you pay off credit card debt .
  • Education expenses  like student loans, paying for college tuition, do your part in making sure your child doesn't accrue too much debt immediately after high school.
  • Fund home improvements, make your home look better and feel better, all while increasing your home's value.
  •  Purchasing an investment property  to finance a second home. Maybe it is just an investment property, or maybe it can be a vacation home. Either way, the extra cash can help cover the cost of down payment.
  • Paying for emergency expenses  Ideally, your refinance will come with better terms than your original mortgage which can be used in any emergency cases or use it for elderly care.
  •   Re-invest the funds into the stock market or real estate.
  • Make necessary purchases like a car ,other large expenses or medical expenses.

 Drawbacks of Cash-Out Refinance:

  • Risk of Foreclosure: If you miss enough payments, you risk losing the house. A cash-out refinance should not be considered with the same approach as opening a credit card. It’s a serious investment, with serious, long-term implications should things go south. Keep this in mind if you plan to use the cash-out refinance loan or secured debt to consolidate unsecured debt like credit cards. Without the proper budgeting and foresight, you could end up making a bad situation even worse.
  • New Loan Terms and Costs: A cash-out refinance, like any other refinance, will come with a host of fees and closing costs to consider. Make sure the numbers add up in your favour before you pull the trigger. Closing costs will run you 2-5% of the new loan amount. 
  • Short Term Solution:Your home is your most precious asset. It should only be used with a clear, thought out goal in mind. You have to ask yourself if a cash-out refinance is more than just a short-term solution to an overarching problem. If you’re having trouble reaching a conclusion on your own, it can help to speak with a nonprofit credit counsellor trained to assess these situations and provide debt relief.
  • Complex Terms: Ideally, you're refinance will come with better terms than your original mortgage. However, that's not always the case and if you are trying to access money in an emergency you may find that you must accept higher interest rates and more restrictive terms than you might like. As with any loan, think carefully about the terms and conditions of a cash-out refi before signing any loan agreements.
  • Lengthy Application Process: Unlike other refinancing programs, a cash-out refi takes time, and you should be prepared to go through an extensive vetting process, just as you would for any new mortgage.

Be cautious about using cash-out refinancing or other long-term financing to pay for current or short term expenses. For example, if you use a cash-out refinance to pay for a car that you will keep for five years, the interest rate will often be much lower than the rate on a new car loan, but you could be paying back the loan for another 20 years. If you use a cash-out refinance to pay back credit card debt, you will have more credit available on the card, but remember that you still owe the same total amount, or a little more if you finance your closing costs.

Cash-Out Refinance Loan Costs

A cash-out refinance loan incurs costs similar to those for your original mortgage. Certain fees are standard, and others are common but may vary. Cash-out refinance costs may include:

  • Origination fee: This is the fee the lender charges for making the loan.
  • Title search: It is performed to ensure the person claiming title to the property is the rightful owner.
  • Title insurance: The policy offers protection to the lender and owner from claims against the property.
  • Appraisal: An appraiser determines the market value of the property.
  • Discount points: Fees can be paid upfront in exchange for a lower interest rate on the loan.
  • Application fee: You pay this fee to apply for the cash-out refinance loan.
  • Credit report fee: The lender charges this to pull your credit report.
  • Document fees: These pay for preparing, notarizing and recording loan documents.

In Brief:

Cash-out refinances are a great way to get cashback using the built-up equity in your home. Paying off debt turns unsecured debts like credit cards and student loans into secured debt with your home as collateral. Using cash-out refinance 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 experienced loan officer who can help guide you through the process is always recommended. 

Be careful! If you don’t pay off the loan amount completely and on time, there is a risk to lose your home. On the other note, you should not do a cash-out refinance if you are not getting a better interest rate on the new loan, you want to spend the money on something such as vacation or unnecessary shopping  and you are worried about being able to pay back the new, larger loan amount.

Bottom Line:

   A cash-out refinance can be a good idea assuming you get a good interest rate. The added advantage is you can easily, ideally quickly pay back the new loan. Make sure you utilize the cash for a worthwhile cause such as home improvements or paying down high-interest debt.

Refinancing can be a crucial decision for homeowners. But no need to worry much about it, Our experts can help you to connect with various lenders, mortgage brokers, agents and get your work done quickly without any hassle. Besides, we monitor your financial needs and observe everyday rates, fluctuations in the market to provide the best rate with confidence, trustworthy. To get more updates and information, feel free to reach out to us. 

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