There’s an awareness that many would-be homebuyers struggle to understand the costs associated with the purchase of a home. Some of it can be blamed on the fact that mortgages have numerous and complex terms, underwriting takes weeks (if not months) to complete, and borrowers shop for mortgage loans ensconced in endless regulations and disclosures.
What you discover the first time you buy a home is that loan fees vary widely. This can be attributed to your lenders’ costs and the risks of assuming your mortgage. Even with additional cost factors, total loan fees (closing costs) will still vary significantly based on your lender, your own qualifications as a buyer, and even the state and county where the home is built and the composition of the neighborhood.
All told, costs paid at closing are substantial, averaging thousands of dollars before you can even get the keys to your home. Refinancing means you’ll pay closing costs again, one way or another, and a cash-out refinance doesn’t get you off the hook either. You’ll pay closing costs for any deal that taps into your home equity, which means you’ll need to make sure the potential savings are worth it.
Refinance vs. Cash-Out Refinance
There’s a fundamental difference between refinancing your mortgage and doing a cash-out refinance of your mortgage. According to Policygenius:
- A refinance of your mortgage replaces the existing loan with a new loan, with the goal of lowering the interest rate or adjusting the repayment terms. You might leverage a better deal than what you had, but you won’t get any cashback.
- A cash-out refinance replaces the existing loan with a brand new loan, but for more than what you owed. You take the difference in cash at closing.
Of these two options (and the many others that exist when the goal is to restructure how you’re paying for your home), the cash-out refinance will always be looked at by lenders as the riskier option.
Not only are you paying closing costs again, but fees on a cash-out also refinance could cancel out a fair amount of the money you’ll get back. A cash-out refi also means you’ll immediately have less equity in your home than you did before closing.
How Much Cash Can You Get During a Cash-Out Refinance?
That’s an important question, so we’re glad you asked.
According to Bankrate, a lender refinancing a conventional loan will typically allow you to borrow up to 80% of your home’s value. But with that being said, the amount will vary depending on your credit score and other qualifications.
You should know that the loan to value, or LTV ratio, can be found by dividing the loan amount you’ve requested by the property value. Lenders who offer loans insured by the Federal Housing Administration (FHA), will also adhere to that 80% LTV. That’s because the Office of Housing and Urban Development (HUD) reduced the maximum FHA cash-out refi loan in the fall of 2019.
Other government-backed programs follow the same type of guidelines.
Only cash-out refinance loans backed by the U.S. Department of Veterans Affairs (VA) can structure a loan for up to 100 percent of the home’s value. You need to be a member of the U.S. military, a veteran other-than-dishonorably discharged or a family member of a US. military member to qualify for a VA loan or a VA refinance.
What Else Should I Know About Cash-Out Refinance Costs?
We’ve already established that a cash-out refi can be costly, especially if it hikes your interest rate significantly. But here are other costs you’ll need to anticipate:
- A cash-out refinance will put you back on the hook for private mortgage insurance, or PMI. If you withdraw the maximum amount of your home’s equity, it means you’ll likely be paying PMI again. That can be an additional cost you weren’t necessarily anticipating, and according to Investopedia, the amount could be substantial. PMI can run between 0.5% to 1% of the loan amount annually.
- A cash-out refinance will require another appraisal of your property to establish the current market value.
- A cash-out will, more than likely, prolong the payment of your mortgage for years, if not decades. It’s something you really have to think about when you put a cash-out refinance up against a traditional refinance and realize you could have paid off your home sooner, at a lower total cost.
- A cash-out may, in some circumstances, temp a homeowner to spend unwisely. If you’re set on going through with a cash-out refinance, make sure you’re not using that money to fund exotic vacations or the purchase of your dream car. Walking away with thousands of dollars needs to lend itself to discipline and pre-planned spending habits such as paying down debt. Homeowners who use the money to make repairs and upgrades to the home are making the best choice to add value back to the property.
- Above all, a cash-out refinance can increase the risk of losing your home. It might not be a ‘closing cost’, but if you fail to repay the loan you’ll face foreclosure, or the process that lenders initiate to take a house from someone who can’t pay the mortgage. The legal action is the main way banks will try to get their money back, as a foreclosure will allow a lender to repossess your home, evict you and sell the property since it was used as collateral in your loan.
Final Thoughts On Cash-Out Refinancing
If you’re seriously considering a cash-out refinance, you should take the time and shop around to match your interests to what a lender can provide. Having a sound plan for using the money you’ll get back will assure you of stable financial footing later on.
Overall, experts say you should expect to pay anywhere from 3 to 6 percent of your new loan amount in closing costs if you do a cash-out refinance. Like a typical closing, those costs include everything from lender origination fees to recording fees and credit report charges.
If your loan amount on a cash-out refinance is $200,000, that means you’ll pay anywhere from $6,000 to $12,000 in closing costs. If you were taking $50,000 of the loan in cash, basic math says you’re spending about 20% of it on closing costs alone.
You may be able to roll your closing costs into your new mortgage, but this strategy also comes at a cost in that you’ll likely pay a higher interest rate. If the goal of refinancing is to make sure the math works in your favor, this is not the best way to go about it.
Above all, tapping into your home equity isn’t a decision you take lightly or make in haste. It should be a strategic move to improve your financial stability and outlook going forward.
- What Is a Cash-Out Refinance?; Policygenius. Accessed at https://www.policygenius.com/mortgages/what-is-a-cash-out-refinance/
- Cash-out refinancing: How it Works and When It’s the Right Option, Bankrate. Accessed at https://www.bankrate.com/mortgages/cash-out-refinancing/
- FHA cash-out refinance guidelines and mortgage rates for 2020, The Mortgage Reports. Accessed at https://themortgagereports.com/27259/fha-cash-out-refinance-guidelines-mortgage-rates
- Revisions to VA-Guaranteed Cash-Out Refinancing Home Loans, Veterans Affairs Administration. Accessed at https://www.benefits.va.gov/homeloans/documents/circulars/26_18_30.pdf
- 6 Reasons to Avoid Private Mortgage Insurance, Investopedia. Accessed at https://www.investopedia.com/mortgage/insurance/avoid-pmi/
- Foreclosures Explained: How They Work and Why They Happen, The Balance. Accessed at https://www.thebalance.com/foreclosure-explained-315702