- What Is Cash Out Refinance
- How Does Cash Out Refinance Work
- Pros of Cash Out Refinance
- Cons of Cash Out Refinancing
- Best Alternatives to Cash Out Refinancing
- Cash Out Refinance FAQ
- Wrapping It Up
Almost everyone looks forward to the day that they will buy a house, being one of the most significant investment achievements. And since it’s expensive to buy one, most people acquire homes through mortgage loans spread through an extended period. The only unfortunate part about all this is that your monthly expenses increase once you buy the house. You have a mortgage loan to service and bills to pay. In addition to this, things keep on changing, and you may want to stay updated with current fixtures and furniture — improving the overall outlook and comfort in your home.
To do all these things and others not mentioned, you will need a good flow of cash which is not always available. Saving enough money for your home renovation and improvement can also be challenging. And when things get here, most homeowners go for Cash Out refinancing, and it could be the only solution available for you as well. If you go for this option, you will not have to rely on personal loans, credit cards, or a new mortgage. Do you want to get cash out of home? Most probably you said, yes. However, before rushing for Cash Out refinance, here is everything you need to know about it.
What Is Cash Out Refinance?
In a simple definition, Cash Out refinancing involves taking a new but larger loan than your current outstanding mortgage balance, and the difference is the amount that goes to your pocket. One important thing to note is that you must have some equity built up on your home. What does this mean? To get cash out of your house, you must have paid your mortgage for some time, creating equity. Another way to increase your equity is home improvement, which automatically raises your home value. The equity is calculated by subtracting the total amount owed as a mortgage from your current home value. Now, the new loan you acquire under Cash Out refinancing will be based on this equity amount.
You must also know that most lenders will not allow you to borrow against the entire home equity. Some will have you retain at least 20 percent of the equity amount. For instance, if your home is worth $320,000 and your outstanding mortgage amounts to $100,000, your equity is $220,000. Now, instead of the leader giving you a loan of $220,000, they might give you $176,000, which is 20 percent less the equity. From this Cash Out refinance, you get to pay the mortgage loan balance and use the balance in whatever needs you may be having.
However, you do not have to utilize the entire amount available under Cash Out refinance. For instance, in this case, you may need $30,000 for a bathroom or bedroom makeover, and therefore should get the outstanding mortgage, $100,000 plus $30,000 rather than the whole $176,000. It can be tempting to take all, but remember, it is still a loan that you will need to pay later.
We mentioned that to get cash out of home, you must know its value to determine if you are qualified and by how much, which means that you might need to do a home appraisal. Prepare your home exclusively in advance to avoid lowering your home value. Also, choose a reliable home appraiser.
Note: Some lenders in specific situations may disregard the 20 percent rule of home equity retaining, especially if you need more amounts for your projects. The decision may be based on aspects such as the type of mortgage loan or credit score. The percentage may also vary from one lender to another depending on internal policies endorsed.
How Does Cash Out Refinance Work?
Usually, to get cash out of home requires you to undergo the same process you did when buying your home. You must determine first if you are qualified before tabling your supporting documents to your chosen lender. In this case, here are the steps to follow:
1. Shop Around for A Lender
Before starting the Cash Out refinancing process:
- Do some research on different lenders offering the services.
- Compare the rates offered by each, terms of qualification, and customer service, among others.
- Once you find one who fulfills your refinancing needs, start the application process.
2. Are You Qualified for A Cash Out Refinance?
You may find that different lenders have varying requirements for this type of refinancing, but the most common determinants include:
• Credit score: In a normal refinancing circumstance, a borrower is required to have a credit score of 580 or more. However, you will need to be a better borrower for Cash Out refinancing — the minimum requirement stands at a credit score of 620 or more.
• Debt-to-income ratio (DTI): You can only qualify for Cash Out refinance if your DTI is less than 50 percent — this is a policy by many lenders. Calculate your DTI ratio by summing up your monthly payments and debts and then divide this amount with your monthly income. For example, if your monthly income stands at $5,000 and total expenses per month are $2000, your DTI equals $2,000 divided by $5000, which is 40 percent.
• Your home equity: This one we have already discussed earlier. You must have built some equity to get cash out of the home. Consider the amount you need on top of the mortgage balance since the lender will not give you the total equity unless you hold a VA home loan. If you are not careful with this calculation, you mind find that the Cash Out refinancing approved is not enough to accomplish everything intended.
3. Should You Take All the Cash Qualified for?
Every borrower must be careful when going for any loan to avoid the temptation of getting more cash than required. In this case, prepare a budget or estimates of your home improvement or renovation projects. If you need the extra money for an investment opportunity or debt consolidation, have a sitting with a financial consultant or use a credit couch to determine the amounts you need.
4. Complete The Application
Once you have ascertained that you are qualified and have estimated the amounts you need for Cash Out refinancing, bring all your supporting documents. Most lenders will ask for a W-2 form, bank statements, or pay stubs for approval purposes.
When the lender gives you approval, sign the closing documents, including deciding whether to pay the closing cost upfront or rolling it over to pay later. The closing cost is usually 3 to 5 percent of the mortgage. Note that you will pay more if you roll this cost over since it becomes subject to interest. Now once closing is done, you only need to wait for your check within 3 or 5 days, unless your lender delays.
Pros of Cash Out Refinance
Cash Out refinancing should not be a way out for everyone unless it is pretty necessary. That said, what are the main reasons to go for Cash Out refinancing. What benefits are you looking up to?
1. It Is an Excellent Way to Consolidate a Debt
Once you get cash out of home, you are free to use this money in whichever way you want. Now, you can use this amount to pay another debt or transfer it to a different account offering better rates than the original. Most people would do this to improve their credit score apart from bettering the terms of their current debts.
2. It Helps You Meet Your Home Improvement Needs
You may have been postponing your bathroom or kitchen makeover project due to a lack of funds but not anymore. Once you get cash out of home, you can use the funds on those makeovers and do repairs that you have been overlooking in the entire house. The good thing is that home improvement and maintenance is an investment project that increases value for your home.
3. You Might Get a Tax Break
Once you get cash out of home, you may qualify for an interest deduction on your mortgage, which is a tax break, reducing the monthly installments. However, the tax break depends on the amount of mortgage interest settled in the year. It may not be much, but definitely something in the long run.
4. Reduced Loan Interest
Any form of refinancing may help you reduce the amount of interest you pay on your new loan. With Cash Out refinancing, you should get a lower interest rate, especially now that you are applying for a larger loan than your original mortgage. The refinancing option is better than going for home equity loans or credit when it comes to interest rates. You might save a lot in the long run.
5. It Gives a Chance to Take Up an Investment Opportunity
By getting Cash Out refinancing, you are freeing up some money that you can use on investment. And taking into consideration the nature of compounding interest, investing the cash received towards retirement savings or college fund is an excellent move.
Cons of Cash Out Refinancing
As stated earlier, Cash Out refinancing is not for everyone. Therefore, before committing to a larger loan, here are a few downsides and aspects to consider.
1. It Comes with A Foreclosure Risk
Usually, a mortgage loan is secured by collateral which is your home. In the case of Cash Out refinancing, you risk losing your home if you stop serving the new loan. It is not a good idea to get this refinance to pay unsecured loans, which leaves you susceptible to losing a home you have been investing in for a long time. And why would you get cash out of the home to repay a student loan that has flexible repayment terms or a car loan that you could have finished paying in few years? The purpose for taking a loan on your home equity must be examined thoroughly.
2. The New Loan Terms Might Be Worse
Cash Out refinancing is a new loan with new terms of payment. You need to take into account all the aspects and costs involved. This includes the fees involved, interest rates, and the term length. Pay close attention to the closing disclosure provided by the lender to understand all the terms. Unless you feel comfortable and can service the new loan without struggle, do not agree to the new terms; it might not be worth it.
3. There Are Costs Involved
You paid closing costs when acquiring your home, and now you have to do the same with your Cash Out refinancing. It ranges between 3 and 5 percent of the mortgage value. Another cost you might need to pay is the home appraisal cost. However, this cost is calculated in the closing cost.
4. The Process Might Take Longer Than Expected
Suppose you can remember the process you underwent when buying your home. In that case, you know very well that it is not always possible to get things done within the days indicated by the law. For instance, your home appraiser is an independent contractor and may take time before they can give a report. Your underwriting report might also take longer to prepare. Therefore, if you need urgent cash, Cash Out refinance may not be your best option.
5. You May Form Bad Financial Habits
We can all agree that money can be tempting. Unless you are financially disciplined, you might get lured into getting more loans as long as available. If you are this kind of a borrower, stay away from Cash Out refinancing. It is easy to start using your credit card balances right after settling them from the Cash Out money — this makes things worse.
Best Alternatives to Cash Out Refinancing
i. Home Equity Line of credit (HELOC): The main difference between Cash Out refinancing and HELOC is that the former is a one-off loan. The latter, on the other hand, is a revolving credit. However, both loans are based on your home equity. With HELOC, your home remains as collateral, but you still pay fees on it, such as closing costs.
ii. Reverse mortgage: For people who are 62 years or older, you can get a reverse mortgage to help fund those home improvement projects. With this mortgage, you are permitted to cash in on home equity, which relieves the mortgage installments burden. The downside is that this amount decreases your equity gradually, leading to reduced assets for the owner and heirs. The borrowed amount gets repaid when the homeowner dies or decides to move out or sell the home.
iii. Personal loan: Taking a personal loan will help you carry out the projects you need without touching your home equity. The house remains as the collateral in this case. However, since this loan is unsecured, it attracts high-interest rates than Cash Out refinance.
iv. Home equity loan: With this loan, you get a lump sum of cash based on your home equity. However, unlike when you get cash out of home, this loan will not change the terms involved. The interest remains fixed. However, being a new separate loan, the overall interest tends to be higher than the original mortgage.
Cash Out Refinance FAQ
i. Is Cash Out refinancing a good option for you?
It is a yes if you are doing it for the right reason. For instance, if you want to consolidate outstanding high-interest loans or fund a house improvement project that increases its value, then go for it. Also, it is a good option if you have enough equity and qualify for a loan with better terms such as low interest rates.
ii. How long does the process take?
Typically, once you apply for Cash Out refinancing, it is supposed to take 30 days. However, sometimes it may take 45 or 60 days due to an increase in demand for refinancing and availability of low-interest rates for the same.
iii. How much is the qualifying equity?
It would help if you had more than 20 percent home equity since this portion gets retained by the homeowner. However, if your loan is a VA, you can get the cash you want with lesser equity since the 80 percent rule does not apply.
iv. Is it a good idea to use Cash Out refinancing to pay another debt?
Yes, you can if the interest rate charged on these loans is higher than the one promised through Cash Out refinancing.
v. What are the main qualifying factors for Cash Out refinance?
It would help if you had a credit score of 620 or above (this may vary with lenders), sufficient home equity, a DTI of less than 50 percent, and generally a good credit history.
vi. Does the Cash Out refi have any impact on credit score?
Cash Out refinancing has no impact on your credit score. However, if you use the funds from this loan to pay another debt, it is possible to improve your credit score a little bit.
vii. What rates are applied on Cash Out refinancing?
In general, mortgage rates have reduced in recent years, including the rate of Cash Out refi. However, the amount of interest may differ from one lender to another. We advise you to check on a few and make a comparison.
Wrapping It Up
Suppose you are contemplating a Cash Out refinancing on your home equity. In that case, you could be making the best financial decision today. However, the outcome of it all depends on the consideration you have made. Access your financial discipline and take this loan for a worthwhile purpose.