Welcome to CashOutRefiTips.com, a comprehensive source of information for homeowners who are considering a cash-out refinance for the home. Here you will learn about cash-out refinance tips, the different types of cash-out refinance, why people do cash-out refinances, rules, limits, credit information, and more. If you have any questions, be sure to send us an email.
What Is A Cash-Out Refinance?
If you own your own home, there may be times that you want to take out equity from the property and put it to use. A cash-out refinance allows the homeowner to take equity out of their property by doing a refinance on their current mortgage that is larger than the current mortgage. (Credible.com)
Most of the new mortgage is used to pay off the first note, and the owner of the home can take whatever is left and use it as they see fit. Usually, you can take out quite a bit of money, but not all of your equity. As with a traditional refinance when you do not take out equity, you could have a higher or lower rate and terms than the existing loan.
How Does a Cash-Out Refinance Work?
The easiest way to understand the process is to break down an example. Let’s assume you have a home worth $350,000 and a current mortgage of $225,000. So, you have $125,000 of equity in the property.
If you want to access some equity as cash – $50,000 for example – you can access it by doing a cash-out refinance. By doing this, the current mortgage will be paid in full and you will have a new loan for $275,000.
You will receive approximately $50,000 in cash, minus assorted closing costs and fees that are imposed by the mortgage lender. Common fees are for a cash-out refinance are:
- Application fee
- Appraisal fee
- Title search
- Credit report fee
- Loan origination fee
Depending on your state, cash out refinance closing costs and fees can run from a few hundred to a few thousand dollars – anywhere from 2-5% of the amount mortgaged.
Why Should You Get a Cash-Out Refinance?
While current federal law imposes some restrictions on what you can do with the cash you receive, if you want to be able to deduct the mortgage interest off your taxes, there is nothing that you cannot spend your equity on. Some of the most common reasons people do a cash-out refinance are: (Investopedia.com)
- Renovating or improving the home
- Paying off higher interest debt such as credit cards and car loans
- Pulling out equity as an emergency fund after the value of the home has risen substantially
- Elder care
- Funding a college savings plan or college tuition
- Funding an IRA or another retirement account
Remember that any time you pull equity of out your home with a cash-out refinance, you are taking a risk. If you cannot pay the new, higher mortgage, you may face foreclosure and the loss of your home. Use caution when
What Does a Cash-Out Refinance Cost?
Remember that when you pull equity out of your home, it is not free. You will be responsible for paying interest on the loan as well as the principle.
Most homeowners take out a 30-year loan when they buy their home because it makes the payments more affordable. If you are doing a cash-out refinance, you may have been paying the mortgage for many years. In this situation, many homeowners opt for a 15-year loan. When you refinance into a loan with a shorter term, homeowners can get a loan with a lower interest rate. (Discover.com)
But say you have a mortgage with a rate that is very low. You could pay a higher rate with a mortgage refinance. So you will not just be paying interest on the cash you remove from the home. You also must pay a higher interest rate on the debt that you had already. In this scenario, a mortgage refinance may not be the best choice for you.
Before you make a decision about a cash-out refinance, compare the terms and rates from several mortgage lenders. It is important to compare the APR for each loan. The APR includes fees and points that each lender charges, in addition to the rate. This allows you to easily compare each lender and what they are really charging you.
What Are The Requirements of a Cash-Out Refinance?
The requirements for a cash-out refinance depend on the lender. But generally, the lender is looking at your creditworthiness. They consider the following factors for most loans:
- Credit score: Having a credit score of at least 700 may increase your chances of qualifying for a cash-out refinance. If you have a credit score of 620, you may get approval from some lenders, but rates may be higher. If your credit score is below 620, getting approval is difficult.
- Debt-to-income ratio (DTI): Lenders usually want a DTI that is below 45% to 50%, including the new home loan.
- Loan-to-value: Your loan to value ratio is used to decide how much equity you have in your home after you do the cash-out refi. To find this out, divide your desired mortgage amount (the current loan plus the cash you want) by the appraised value of the property. Most mortgage lenders want borrowers to have a combined loan to value of no more than 75% to 85%.
- How long you owned the property: It is common for a mortgage lender to require that you own your home for a minimum of a year before you refinance. If you want to do a refinance, you may be required to pay a prepayment penalty.
What Are The Tax Implications of a Cash-Out Refinance?
You do not have to pay income taxes on the money you pull out in a cash-out refinance because the money is not defined as income. But you can claim the mortgage interest deduction for the ‘home acquisition’ part of the loan. This is the amount owed on the old loan, plus proceeds that you used to improve your home.
The mortgage interest deduction lets you deduct the interest paid on certain mortgage debt from your taxable income. Before, you could claim the deduction on up to $1.1 million in total debt, plus as much as $100,000 in home equity debt that was used for any reason.
But beginning with 2018 tax returns, interest paid on your cash-out refi can only be deducted if it is used to make major improvements to the home. Also, the limit for the new loan is $750,000. So if you want to refinance more than than, there may be tax implications, so you should talk to your tax advisor.
What Are the Alternatives to a Cash-Out Refinance?
A cash-out refinance is a good tool for homeowners who want to tap home equity, but it is not the only option.
Limited Cash-Out Refinancing
This option works like a cash-out refinance but it limits what the cash can be used for. Money from a limited cash-out refinance is usually limited to the following:
- Covering the fees and closing costs of refinancing
- Pay off a loan for energy-related home improvements
- Buy out the co-owner of a property
- Convert a construction loan
- Consolidate first and second mortgages into a single loan
- HELOC or home equity line of credit
A HELOC is a second mortgage that allows you to tap home equity without redoing the first mortgage. It works like a credit card in that you can access the funds as you need them up to a maximum limit. The rate is usually variable, meaning it will go up and down with a common index, such as LIBOR or the prime rate.
Home Equity Loan
A home equity loan is another type of second mortgage that you can use to tap your equity. Rather than a line of credit, you can get a single, lump-sum payment from your lender. This loan usually has a fixed interest rate. So you have a set payment for the life of the new loan. You can expect a slightly higher rate than on your first mortgage.
Tips for a Cash-Out Refinance
- Pay yourself: Use some of the cash from your refinance on investments that could pay you a rate of return in the future, such as home improvements, investment properties, or getting a college degree. (Military.com)
- Ask for a good-faith estimate: Most mortgage lenders should give you a good-faith estimate of your closing costs within 72 hours of getting your loan application. This is very important so you can avoid any hidden closing costs.
- Get everything in writing: A verbal agreement with a lender is nice, but you must have a written statement of loan terms. It should include interest rate, how long the rate lock is, and other details.
- Refinance into an adjustable-rate: If you do not plan to stay in the home for many years, consider refinancing into a lower, adjustable-rate loan. By the time the rate adjusts in three or five years, you may have moved.
- Consider paying points: You can pay money upfront to lower your interest rate permanently. This might make sense. One point equals one percent of the loan amount.
- Beware of paying off high-interest debt: Doing so with your equity MIGHT make sense, but if you run up your credit cards again, you have to pay the credit card bill AND a higher mortgage payment. And your house is the collateral on the new mortgage.
When you decide to get a cash-out refinance, you should carefully way the pros and cons. It comes down to how much money you are borrowing, what you are using it for, and whether you are sure you will have the income now and in the future to pay the higher mortgage amount.