Cash-Out Refinance for Emergency Fund

There are some of us whose personal finance practices are in solid shape. We have an emergency fund of at least 3 months’ expenses (if not more), and goals to save $1 daily or $10 weekly. We avoid high-cost debt, owe just a fraction of our monthly net income to bills, and hold both savings and investments.

Realistically, no one needs an expert to tell them that having some sort of savings buffer is just good old common sense. But for many Americans, this scenario is little more than an unattainable hope … a pipe dream. 

According to Bankrate’s Financial Security Index, nearly 3 in 10 adults across the country have no emergency savings. Only 1 in 4 said they have what would amount to a ‘rainy day fund’ but not enough to cover months’ worth of expenses.

If you’re one of those people who might be looking to solve a savings crisis and don’t know where to turn, the answer may be right over your head in the form of home equity.

What is a Cash-Out Refinance?

If you hold equity in your home — that’s to say the difference between the property value and what you still owe on it —  a cash-out refinance may be one of the best ways to borrow money.

It works like this: You decide to refinance your mortgage and take out a bigger (yes, we said bigger) mortgage, pocketing the difference in cash. So let’s pretend that your home is worth $375,000 and the current principal balance on your mortgage is only $215,000. That means you’re in excellent shape where equity is concerned. You can take $50,000 (which bumps your new mortgage to $265,000), walk away with that large sum of money after closing, and still maintain equity in your home.

Does this sound too good to be true? Well, it’s not. A cash-out refinance can be a surefire way to give yourself some breathing room when financial trouble strikes and can be the solution you’re looking for to start or maintain an emergency fund.

The Ins and Outs of Applying for a Cash-Out Refinance

Loan applicants shopping around for a deal need to understand something very important — it’s OK not to jump in with the first lender that says ‘yes’, but you’ll eventually have to go through the underwriting process with one of them. That means you need to focus on the whole application, starting with the appraisal of your home.

The New York Times suggests you prepare ‘income explainers’ and over-document everything you think a lender will be looking for. This can be everything from pay stubs to bank records, tax returns, and paid bills.

You should also check in with your lender to talk specifically about the home appraisal, and what kind of issues can result in a lowballing of your property value. Proof of remodeling, including before-and-after photos, receipts, and paperwork that shows specific work was done by a licensed contractor can go a long way for your appraisal, along with comps in your neighborhood.

Finally,  remember that lenders will typically check your credit report throughout the underwriting process.  Make sure you haven’t applied for a new credit card, auto loan or other borrowing until your application is approved.

Other Rules of Cash-Out Refinancing

Rocket Mortgage and many other lenders will remind you of various things to consider with a cash-out refinance. One of the most important is that conventional loans require you to leave a certain percentage (between 15-20%) of equity in your home after a refinance. FHA loans require at least 15% equity to remain, meaning you can’t max out the value of your home.

Additionally, there will be credit score requirements and lenders will scrutinize your debt-to-income ratio (DTI), or the total amount of your monthly debts weighed against your total monthly income. For example, if you pay $1,600 a month in bills and you have a total income of $3000, your DTI is about 53%. Many lenders will require that your DTI fall below a certain threshold in order to refinance your loan.

Benefits of a Cash-Out Refinance

Circling back to the need for an emergency fund highlights one of the reasons people consider and act on refinancing opportunities.

As U.S. News & World Report points out, one of the main benefits of a cash-out refinance is just that — the cash. Having it can immediately relieve stress on your budget.

By having an emergency fund, you can use the money for things like medical or dental bills. Many people also use it for veterinary expenses for their pets. In the event of job loss or interruption of income, having cash on hand becomes imperative for day-to-day necessities.

Beyond major expenses, some people split the cash out on a refinance and put some of it aside for other reasons. Many people use the money for:

– Consolidating debt by paying off high-interest credit cards.

– Funding major repairs or renovations at home.

– Paying off school loans

– Adding to existing investments or buying investment properties

Overall, experts say you should get in the habit of regularly saving money once an emergency fund is established. Additionally, if you are employed full-time and making contributions to a retirement plan at work, you should also take the initiative to put a portion of each paycheck into a high-yield savings account.

No matter what, achieving financial stability should be part of your endgame in applying for a cash-out refinance.

Final Takeaways On Cash-Out Refinancing For Emergency Funds

Financial stability is difficult for many Americans to achieve. More than 60% of respondents to a Prudential survey taken in late 2018 said they didn’t have enough savings to handle a $500 emergency.

Many more people need an easily accessible savings account, and it needs to be padded for unforeseen expenses. That alone can be the difference between a small financial hiccup that is easy to overcome and something that can derail you completely.

Refinancing your mortgage can offer big benefits, and a cash-out refinance is a means to an end with a big upside. But remember, everything comes back to what you really want to accomplish with your refi. A successful refinance in this situation would mean you’re accounted for your goals in the short and long term, establishing an emergency fund and utilizing cash out appropriately.

Noting the types of emergency expenses that befall many people, some experts even recommend having enough cash on hand to cover expenses for up to a year or more. Having a hearty emergency fund established from a cash-out refi can give you peace of mind now and in the future.

References

Author: Bryan Dornan

Bryan Dornan is a financial journalist and currently serves as Chief Editor of Cash Out Refi Tips.com. Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.

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