If you’re a homeowner in need of cash, a cash-out refinance is one option worth exploring.
These mortgages turn the equity in your home – or the part of the house you actually own – into cash. You can then use these funds to cover home repairs, pay off debt, or meet any expenses you may deem necessary.
Cash refinances tend to be more popular when the housing market is hot and home values are rising. This allows owners to access more equity and, therefore, more cash.
What is a cash refinance?
A cash refinance replaces your existing mortgage with a new one, but with a larger balance. You then get the difference between two balances in the form of cash.
This type of loan allows you to take advantage of the equity in your home without selling it. Like a traditional refinance, you may be able to get a lower interest rate, but the funds from a cash refinance can be used for any purpose. It’s an attractive option for homeowners who need cash and want to take advantage of the equity they’ve built up in their property.
Some homeowners use them to improve or renovate their home. Others use them to pay off their debts.
“With the average mortgage refinance rate only a fraction of the average credit card interest rate, cashing in to pay off credit card or other higher interest debt can be a financial decision. intelligent,” said Al Murad, executive vice president of AmeriSave Mortgage Corp.
Since a cash refinance replaces your existing mortgage, the repayment works the same way. You will make monthly payments to your lender, usually for 15, 20 or 30 years, depending on your term, until the balance is paid off.
It is important to note that cash refinances are not the same as home equity loans. While both allow you to turn your equity into cash, a home equity loan is a second mortgage, meaning a loan in addition to your main mortgage. This means that you will have two monthly payments in the future.
How does cash-out refinancing work?
The cash refinance application process is very similar to getting a traditional mortgage. You complete an application (it doesn’t have to be with your current lender), submit the required financial documents, have your home appraised, pay closing costs, and then close your new loan.
The new loan is used to pay off the old one and you receive payment for the remaining amount.
Here’s an example: Let’s say your home is worth $500,000 and you have a current mortgage balance of $250,000. In this scenario, you could request a refinance of $325,000. After closing, the new loan will pay off the old one ($250,000) and you will receive $75,000 to use as you wish.
What do you need for a cash refinance?
Cash-in refinances often come with stricter requirements than traditional mortgages.
“Lenders view cash refinance loan options as relatively higher risk,” says Jeremy Drobek, mortgage originator at AmeriFirst Home Mortgage. “The new loan amount leaves you with a larger balance than the original mortgage amount and less equity.”
While the exact requirements vary by loan program and lender, here’s what you can generally expect when applying for a cash-out refinance:
- Credit score: Your credit score will affect your ability to qualify and the interest rate you will receive. You probably need at least a score of 640 or higher, although some lenders can go as low as 580. The higher your credit score, the better the interest rate you can get.
- Debt ratio (DTI): Your DTI indicates how much of your income is taken up by debt. Typically, you’ll need a DTI of 43% or less, which means your minimum monthly payments can’t exceed 43% of your take home pay. In some cases, up to 50% DTI may be permitted.
- Loan-to-value ratio (LTV): LTV reflects how much of your home’s value your loans represent. Lenders generally want an LTV of 80% or less, which means you should retain at least 20% of your home’s equity after you refinance.
- Other requirements: You will also need proof of employment and a home appraisal, which confirms the current value of your property.
Keep in mind that these are only general requirements. It is always best to check with the lender for details.
Advantages of cash refinancing
Depending on your situation, cash-in refinancing can have many advantages. Among them:
- You can use the funds for any purpose. You can use them to pay credit card bills, medical bills, school fees, or home improvement projects.
- You might get a lower interest rate. If current mortgage rates are lower than your existing mortgage rate, refinancing could save you money on long-term interest payments.
- Interest is tax deductible. You can deduct the interest you pay on mortgage debt of up to $750,000. Keep in mind that you can only take advantage of this deduction if you itemize your tax returns (most people take the standard deduction each year).
- You may be able to add value to your home. If you use the funds to renovate your home, you could increase the value of your home – and your eventual profits – if you choose to sell the home or tap into your equity again later.
- They can help you pay off your debts. Since mortgages generally have lower interest rates than other forms of consumer debt (credit cards, personal loans, etc.), using cash refinance to pay off other balances could save you money in the long run.
For existing homeowners, a cash refinance can also be a good alternative to selling and buying a new home, especially in a high-cost market.
“Because of the state of the market — prices have gone up so much — some people are doing a cash refinance and then using the money to redevelop, to stay in their house,” Drobeck says. “Right now a lot of people are saying, ‘Forget about selling the house and paying $20,000 in realtor commissions. Let’s do a cash refinance, get $50,000 and redo the kitchen or expand the house. ”
Disadvantages of cash refinancing
While cash refinances certainly have advantages, these loans also have disadvantages. Among them:
- It replaces the rate and terms of your current mortgage. Sometimes this can work in your favor and lower your interest rate and monthly payments. Or it may mean swapping your current low rate for a higher rate.
- There are closing costs. You can expect to pay around 3-5% of the loan amount in closing costs. If you don’t plan on staying in the house for long, these costs may not be worth it.
- You may have a higher monthly payment. Since a cash-out refinance increases your balance — and potentially your interest rate — you could have a higher monthly mortgage payment as a result.
- Repaying your loan may take longer. If you refinance to a longer-term loan, it extends your repayment schedule (eg, refinancing to a new 30-year loan when you only have 10 years left on your current loan).
- You may owe more on your home than it is worth. If your home were to lose value, you might owe more than it’s worth. When this happens, you may not be able to sell the house and pay off your mortgage balance.
Ultimately, it’s important to remember that refinancing means completely replacing your existing mortgage, which also means a new rate, new payment, and new terms.
“It usually makes sense when current mortgage rates are lower than your existing loan terms,” says Jon Giles, head of consumer direct lending at TD Bank. “However, if rates are higher, other variables must be considered and analyzed to determine if this is a smart long-term financial decision.”
The take-out sale
Cash-in refinancing may be a smart move for some homeowners, but it’s not for everyone.
If you’re not sure whether a cash-out refinance can help you achieve your goals, talk to a loan officer or mortgage broker. They can help you determine if cash refinancing, or perhaps an alternative product like a home equity loan or HELOC (home equity line of credit), is best.
“Everyone’s situation is different,” says Drobeck. “Talk to a loan officer and hash out the details.”
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