Cash-Out Refinance

Cash-Out Refinance – What is it?

A cash-out refinance is a type of mortgage refinancing that allows you to take out some of the equity you have built up in your home as cash to pay off other loans, remodel, pay medical bills, or use it for any other purposes you wish.

Plus, cash-out refinancing, when used to pay off other high-interest loans (like credit cards, auto loans, etc.) usually transfers those loans from a higher interest rate into lower refinance interest rates and required monthly payments.

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Watch Mortgage Professionals discuss How Cash-Out Refinancing Works or read the full transcription here.

The Key To Cash-Out Refinancing – The Equity In Your Home

A cash-out refinance allows you to get some of the equity you have built up in your home back out in cash. 

Your home’s equity can increase in two ways:

1. You’ve paid off some of your loans through your monthly mortgage payments. Every time you make a mortgage payment, you pay off a small percentage of your loan. 
2. Your home increases in value.

If you ask a mortgage lender for a cash-out refinance, they will usually require you to keep at least 20% equity in your home, so they will be willing to loan you up to 80% of the value of your home. 

So, if your home is worth $200,000, they will usually require you to have at least $40,000 in equity ($200,000 * 0.2 = $40,000) once the new loan is closed. When you receive a cash-out refinance the lender will usually give you a loan for the value of the home (minus any refinancing and closing fees) minus the required equity. In this case, the lender would give you $200,000 minus the $40,000 equity, so they would loan you about $160,000 (minus any refinancing and closing costs rolled into the loan.

From that amount, they would first pay off your old mortgage, then give you whatever is leftover within a few days of your loan closing.

Let’s look at 3 scenarios for a cash-out refinance (we’ll make it simple by not talking about refinance and closing costs, but remember that those costs will be subtracted before they give you the cash.):

1. You bought a home several years ago for $250,000 and made a downpayment of $50,000, so you took out a mortgage on it for $200,000. Since then you’ve made your mortgage payments faithfully and have now paid off $40,000 of your loan. That plus the original $50,000 downpayment means you have equity in your home of $90,000.
   
   If your home hasn’t changed in value, (it is still worth $250,000,) the lender would likely loan you about $200,000 ($250,000 less the $50,000 in required equity.) 

But first, before giving you the money, they would pay off the remaining $160,000 in your mortgage (your original $200,000 mortgage minus your $40,000 in principal payments you’ve made so far).

This means that you would get back about $40,000 in cash when your loan closes as cashback.

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1. Let’s take the same scenario, except your home’s value has now increased to $300,000.
   
   In this case, the required equity in your home would be $300,000 * 20% = $60,000. So the lender would be willing to loan you around $240,000 ($300,000 minus $60,000.)
   
   The first thing they would do is to pay off the $160,000 you still owed on your mortgage, meaning you could receive up to $80,000 ($240,000 minus $160,000) in cash back after closing.
    
2. You can even get cashback if you haven’t made much of a dent on your mortgage, but the value of your house has considerably increased.
   
   Let’s suppose that you bought your home for $250,000, with a 20% ($50,000) downpayment. So you owe $200,000 on your mortgage.
   
   Meanwhile, the housing prices in your area have spiked and your home is now worth $300,000. You could now do a cash-out refinance of your home where your lender would be willing to loan you up to 80% of that $300,000, giving you a loan of $240,000.
   
   But remember, before they give you money, they first pay off your old mortgage of $200,000, so your cash out amount would be $40,000 ($240,000 from the new loan, minus $200,000 used to pay off your old mortgage.)

I know, that was a lot of math. Let’s make the calculations easier for you with a table:

Cash-Out Refinancing Calculator

1. Your home’s current value:                       _______________
2. Required equity (A * .2):                           _______________
3. Potential refinance amount (A – B):           _______________
4. Amount remaining on current mortgage:   _______________
5. Potential cashback (C – D):                      _______________
   Remember, this amount will be reduced by refinancing and closing fees

What Can You Do With The Money From a Cash-Out Mortgage?

Simple answer: anything you want.

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Frequently these amounts are used to

• Pay off high-interest debt
• Pay off student loans
• Remodel, repair or renovate
• Buy a new car
• Start a business
• Etc.

It’s yours to spend as you wish.

What Are The Requirements For A Cash-Out Refinance?

Every lender has different requirements, but here are some typical ones.

A Credit Score of at least 620 (the higher the better)

A basic refinance usually requires a credit score of at least 580. Because a cash-out refinance is a higher risk to the mortgage lender, they typically require a score of at least 620.

Greater than 20% Equity In Your Home (the higher the better)

Since most lenders require at least 20% equity after a cash-out refinance, the amount of cash you will receive is directly related to the amount of equity you have above 20%. Note, there is an exception: if you currently have a VA loan and you are doing a VA refinance, the equity requirements are different. Contact us if you qualify and we can give you the details.

A Debt-To-Income Ratio (DTI) of Less Than 50%

Your debt-to-income ratio is calculated by totaling your monthly payments for all your debts (mortgage payments, student loans, credit cards, car payments, etc.) and dividing them by your monthly income. Let’s imagine that you make $5,000 a month. At that level of income, your monthly debt payments would need to be less than $2,500/month to be able to qualify for a cash-out mortgage refinance ($5,000 times 0.5 = $2,500). If your actual monthly debt payments were $2,000, your debt-to-income ratio (DTI) would be $2,000 divided by $5,000 = .4 which means your DTI would be 40%, which would be less than the 50% limit. (That’s good!)

Important Facts About Cash-Out Refinancing

There are several important factors you should consider when considering a cash-out refinance.

You won’t get the cash immediately

You can’t just walk into a mortgage lender’s office, apply and get a check. Your loan will have to go through underwriting like any other mortgage or refinancing, so they will request all of your financial details like they did when you initially obtained your mortgage. That process of obtaining and analyzing the data takes time, usually a month and a half to two months, depending on how busy they are, your responsiveness to their requests, and the type of loan for which you are applying.

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Every lender has their own requirements

Yes, we gave some typical requirements in this article. But your lender (or the type of loan you are requesting) may have different requirements.

Were you denied a cash-out refinance loan by another lender? Contact us, we may be able to help.

Your finances need to be pretty clean to qualify

The requirements for a cash-out loan tend to be stricter than those to qualify for a regular refinance loan. If you have significant credit issues, unstable income, high debt, or other issues, you may not be able to qualify. 

Not sure if you can qualify? Contact us – we’ll answer your questions and may be able to help.

You’ll need an appraisal*

Since the value of your home is key to the equity calculations, your lender will order an appraisal from an independent third party. The cost for this appraisal will be included in your loan’s closing costs, which can be paid outright or may be able to be included in your loan amount.

* If your current mortgage is a VA or FHA loan, there may be a streamlined refinance option that does not require an appraisal if you’re not taking cash out.

You will have a new loan

Your new loan won’t be the same as your old mortgage. The payments, interest rate, and length of your loan will probably be different from your old mortgage, which you should keep in mind. For example, if you do a cash-out refinance on a 30-year mortgage for which you have now made payments for 5 years, you will probably start a new 30-year mortgage (though you should discuss the length of your new loan options with your mortgage lender as part of your application process.)

You will have to pay closing costs

Ask your mortgage lender for an estimate of how much you will have to pay in closing costs for your loan before you apply.

Pros and Cons of a Cash-Out Refinance Loan

Cash-out refinances come with advantages and disadvantages.

Advantages include:

• Your interest rate may be lower than your original mortgage.
  This is one of the main reasons people refinance – you should check current mortgage refinance rates regularly. If they drop by .5% 1% or more it is usually worthwhile to refinance your mortgage.
• You may be able to reduce the interest rates on your other debts.
  If you choose to consolidate debt like credit cards or other debt, those loans are usually costing you way more than the interest rate you can get on a mortgage refinance, reducing your interest costs and monthly payments.
• You can possibly improve your credit.
  A cash-out refinance could reduce a key factor in your credit report, called your credit utilization rate, if you use the cash to pay off your other debts.
• You can reduce your taxes.
  Mortgage interest is usually tax-deductible in the U.S. versus debt on credit cards and other types of debt, which is not usually tax-deductible.

Some disadvantages include:

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• Your interest rates could go up.
  You should carefully consider whether refinancing is a good idea if current refinance rates require you to pay a higher interest rate.
• Refinancing short-term debt into long-term debt (mortgages) means you’ll be paying off that debt for decades.
  Mortgages usually range from 10 to 30 years. Rolling your credit card and other short-term debt into your mortgage means you will be paying off that debt for the entire period of your mortgage, which may not yield the savings you think it will.
• You may end up losing your home.
  You should always keep in mind that if you ever stop paying your mortgage, you could lose your home. Refinancing, especially if it resets your mortgage to a longer time period, increases the risk that at some point you won’t be able to make payments and could lose your home.
• You should avoid the habit of running up your credit cards then rolling those amounts into your mortgage.
  Some people fall into a trap of paying off their credit cards with a cash-out refinance, then putting a bunch of new purchases on those cards, leaving them with the same high payments they used to have with lower equity on their home. If that’s a pattern in your life, you may want to seriously consider whether it’s a good idea to do a cash-out refinance.

Is a Cash-Out Refinance Good For You?

Cash-out refinances can be a good idea if used for certain types of purchases like:

• Home improvement projects that increase the value of your home.
• Investment purposes.
  In times of low-interest rates, some people choose to pull equity out of their homes and invest it into investments like their retirement savings or investment properties.
• High-interest debt consolidation.
  High-interest debt, like credit cards, car loans, etc. usually have significantly higher interest rates than rolling those costs into a mortgage.
• College Education.
  Some people find that tapping into the equity of their home to pay for a child’s college expenses can be a good option, especially if the mortgage rates are lower than student loan interest rates.

Have questions about a cash-out refinance?  Mortgage professionals are standing by to answer your questions!

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