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What Is Cash-Out Refinancing?

Lee Nelson
The Mortgage Reports contributor

Cash Out Refinancing: Many Loans For Many Reasons

What is cash out refinancing? It’s a way to exchange your home value for cash, without selling it. As you faithfully pay your monthly mortgage payments, you accumulate equity.  And many times, your property increases in value over time.

That means you have the opportunity to get money for that equity. It’s called a cash-out refinancing.

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What Is Cash Out Refinancing?

There are three basic kinds of mortgage:

  • The “rate and term” refinance replaces your old mortgage with a new one, and the new loan amount is the same as the closing balance of the old loan.
  • The “limited cash out” refinance allows you to wrap the refinance closing costs into the new mortgage, so its starting balance is a little larger than the closing balance of the old mortgage.
  • The “cash out” refinance allows you to refinance with a larger mortgage than you need to just pay off the old loan and the closing costs of the new one.

This new mortgage results in the borrower getting cash in hand at closing, or paying off debt that was not used for the purchase of the home, says Jerry Calnin, branch manager at Fairway Independent Mortgage Corp. in De Pere, Wis.

Who Benefits From A Cash Out Refinance?

Cash out refinancing is one of the cheapest sources of money available. That’s because your home secures the loan. This makes financing less risky for lenders, and they reward you with lower interest rates.

Cash out refinances can help improve cash flow by paying off other debts with higher interest rates or payments. They also can be good sources of funding for education for children, Calnin explains.

Actually, the money can be used for almost anything, including home improvements, investments, medical bills or a swimming pool. Some of those home improvements can actually increase the value of your home, adding more equity back into the house.

Cash out refinancing is usually less expensive than selling your home to get money. Experts put the cost of selling, moving and buying a new home at about ten percent.

How Much Cash Can You Get?

Calnin explains that it depends on the loan program and your qualifications. The total loan amount won’t normally exceed 80 percent of your property value for a conforming conventional loan, 85 percent for an FHA loan, or 100 percent for a VA loan.

In most cases, cash out refinancing costs more than rate-and-term or limited-cash-out refinancing, and those extra costs reduce the amount of cash available to you.

Should You Choose A Cash Out Refinance?

Before refinancing, you should ask yourself:

  • How long do I intend to stay in this home?
  • How will this refinance affect my monthly payments?
  • Is this the best use of my equity?

If you don’t plan to stay in your home very long, or you can’t improve on the terms of your current mortgage with a new home loan, it might be cheaper and smarter to choose a home equity loan to get your cash.

“Most refinances will involve closing costs,” says Calnin, “So you need to have enough benefit to retire the closing costs in a reasonable period of time.”

if you plan to use the proceeds for something like a new car or vacation, think twice. Finance experts don’t recommend financing short-term items with long-term loans. Do you really want to spend the next 30 years paying for a week’s fun or a car you keep for five years?

Cash Out Refinance Pitfalls

Home equity is the primary way many families build wealth, according to Harvard University’s Joint Center for Housing Studies. Cashing out home equity is just like pulling money out of your retirement account, because when you sell your home, you’ll have less equity for your future.

In addition, cash-out refinancing costs can be higher, and they are based on the entire loan amount, not just the cash out.

If you owe $100,000 and want $10,000 cash out, and the fee for cash out is one point (one percent of the loan amount), it can cost you $1,100 to borrow $10,000. That’s an 11 percent surcharge.

Cash Out Refinance Alternatives

The Consumer’s Guide to Mortgage Refinancings emphasizes that you should consider alternatives before taking a cash-out refinance.

Home equity lines of credit (HELOCs), for example, often come with no closing costs. They can be great for funding a series of home improvements or paying annual college tuition.

Home equity loans are (usually) fixed-rate second mortgages that may be cheaper than cash out refinancing.

Lifestyle changes are an option for slimming down expenses. And there’s always eBay if you’ve got extra stuff you can sell.

Qualifying For A Cash Out Refinance

Underwriting standards for cash out refinances are usually higher. That’s because these mortgages are riskier for lenders than rate-and-term loans.

Many lenders won’t allow cash out refinancing for vacation or investment properties.

For a Fannie Mae or Freddie Mac cash out refinance, the minimum credit score for cash out refinancing is 40 points higher than for rate-and-term loans.

If you want an adjustable rate mortgage (ARM), expect lower loan-to-value limits and tougher underwriting.

What Are Today’s Mortgage Rates?

Current mortgage rates for cash out refinancing are still very low, thanks to favorable economic conditions. While cash-out refinancing does cost more than a traditional refinance, it’s still one of the cheapest sources of money.

If considering a cash-out refinance, compare options from several mortgage lenders, and choose the best deal they offer you.

Verify your new rate (Sep 16th, 2019)