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What Does Cash Out Refinance Mean?
A cash out refinance (popularly known as a cash out refi) refers to when you refinance your existing mortgage loan to a new one that is larger than the current one.
If you’ve built up some equity in your home and need cash now, this is one of the best, and most cost-effective, options to get money into your bank account quickly.
How does cash out refinance work?
It’s actually a pretty simple concept. For example, assume your house is currently worth $350,000, and your current outstanding mortgage on it is $250,000. What that means is that your house’s value has increased from $250,000 to $350,000, making your built-up equity worth $100,000.
Equity is the difference between how much the house is worth and how much you owe on it. The two main ways of building equity are paying off your loan, so you owe less, or making improvements to your house, so it is worth more.
If you want some cash, let’s say $40,000, you could do a refinancing, get a new loan worth $290,000 (the $40,000 that you need is added to the $250,000 that you already owe from your current mortgage), and then keep the $40,000.
Cash Out Refinance Rates and Costs
Just like any other mortgage, there are fees and closing cost involved. These costs include the appraisal fee, underwriting fee, processing fee, and bank charges. The costs, together with the interest and principal amount, determine your repayment amount.
If you don’t have the money upfront, or don’t want to use part of the money you are borrowing from your home equity right away, it is possible to opt for a cash out refinance with no closing costs. When this happens, you transfer the costs to a third party, usually the lender or broker. Talk to one of our HomeRate Mortgage experts to find the best situation is for you.
The Guidelines to Know
The more information you have, the easier it will be to see what you apply for and what will work for you. Here are some cash out refinance guidelines that will come in handy as you shop for a refinance lender.
1) Cash out refinance on inherited property
If you are inheriting the property, you will have to wait for at least two years before you can refinance it. You will also have to pay all its debts and expenses before you take over the title.
2) Cash out refinancing taxes
You don’t have to pay income tax on the money you take out, but you will have to pay taxes on its interest.
The size of your new mortgage is usually determined by the value of your house – a concept called loan-to-value ratio. Typically, in cash- out-financing lenders will offer up to 80% of your home’s value.
4) Using the cash
There are no restrictions on how you can use your cash, but the new, bigger loan will first be used to pay off your existing mortgage balance and all its associated closing costs. The remaining funds are yours to use as you wish.
5) Loan terms
As mentioned already, cash out refinances lead to the creation of a new loan with new terms, including lower interest rates and monthly payments.
6) Cash out refinance credit score requirements
The higher your credit score, the better the rates you’ll get. While a FICO score of 700 or higher will put you in a good position to negotiate terms, you can still be eligible for a cash out refi if you have less than perfect credit.
To get the most from your refinance, do small but critical repairs and maintenance jobs to your house before it is appraised. That way when your home is valued at a higher rate, you’ll be able to borrow a larger amount with your mortgage refinance.
Cash Out Refinance Limits
For most lenders, the maximum amount you can borrow on a cash out refinance is 80% of your loan-to-value (LTV) ratio. Your LTV ratio is determined by two factors:
- The current value of your home
- The total amount of current existing mortgage(s) against your house
Some lenders usually reduce the LTV to 70% for any property worth over $500,000 so you might want to confirm that with your lender before you apply.
Cash Out Refinance Qualifications
Refinancing does sound exciting, doesn’t it? You are probably wondering ‘can I do a cash out refinance?’ Sure you can if you meet the following requirements:
- Loan-to-value ratio: you must have a LTV value of at least 80%. Some lenders go as high as 85%, while others drop the value to 70% for any property worth $500,000 and above.
- Creditworthiness: there is not set limit for your credit score, but the better your score, the higher the chance is that you’ll be approved for a cash out refi
- Time in residence: again, this is just a guideline, but lenders generally want to see that you’ve been living, and making payments on your current mortgage, for at least a year before you quality for a cash out refi
Is Cash Out Refinance A Good Idea?
If you’re in a position where you need cash and have equity in your home, there are many benefits of cash out refinance. Here are some few:
- Access to money: a cash out refi puts money in your pocket for everyday expenses like home repairs, paying off student loans, credit cards, or any other expenses you have.
- Lower interest rates: if mortgage interest rates drop then a cash out refi might be a good idea so that you can take advantage of better rates and get some money out at the same time.
- Debt consolidation: you can use the cash to pay off debts like credit cards and other loans, so you’ll have fewer bills to manage and worry about every month.
- Better credit profile: by using the cash to consolidate your outstanding debt you will improve your credit score, which makes you more likely to get better rates for all types of loans in the future.
If you’re thinking of exploring this option, let HomeRate Mortgage help find the best solution for you.
Disclosure: Even though a lower interest rate can have a profound effect on monthly payments and potentially save you thousands of dollars per year, the results of such refinancing may result in higher total finance charges over the life of the loan.