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How to use a cash-out refinance to buy another home

Peter Miller
Peter MillerThe Mortgage Reports Contributor

In this article:

One way to buy a vacation or rental home is by using the equity in your current residence.

  1. Your ability depends on the amount of your home equity and your credit rating
  2. If you want to buy and then sell or refinance one of the homes, consider a bridge loan
  3. In some cases, a home equity loan or HELOC might be the most affordable and fastest choice

These are great choices when time is a factor or you can more easily qualify for a refinance than to buy a rental.

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Cash-out refinance to buy another home can be a smart choice

Can you get a cash-out refinance to buy another home? For millions of American homeowners, it’s an increasingly reasonable question because real estate equity has soared in recent years. According to government figures, homeowner equity went from $6 trillion in 2009 to almost $15 trillion at the start of this year.

Related: Homeowners see the biggest jump in home equity in 4 years

We’re talking about a mountain of cash, equity that can be readily converted into financing for school, business start-ups or the purchase of a second home or investment property. But there’s a catch. The equity you have may not be available to buy a replacement property. Structure cash-out refinancing the wrong way and all equity on earth won’t help you get a new house.

How much equity do you have?

At first, it may seem that the equity issue is simple. You bought a house for $142,530 in June 2000 with 3.5 percent down. The interest rate was 6.65 percent. You stayed through the 2001 dot-com bubble and the 2007 recession. By June 2018, the property is worth $276,900.

Related: FHA cash-out refinance guidelines for 2018

These numbers are real. The median sale price in June 2000 was $142,530. It rose to $276,900 in June 2018 according to the National Association of Realtors. You bought with 3.5 percent down with an FHA mortgage. The interest rate was 6.65 percent back in 2000, and as of this writing, we’re around 4.6 percent.

How much can you borrow?

In general terms, you paid $142,530 in 2000 with 3.5 percent ($4,989) down. The mortgage was for $137,541.

After 18 years, the remaining loan balance is down to $87,440. (In practice, you would likely have refinanced after 2009 when mortgage rates fell significantly.)

You now have a property worth $276,900. Less $87,440,your equity is $189,460.

Can you really get a check for almost $190,000 from lenders?

Related: 2018 (the year of HELOCs and cash-out refinances?)

Lenders generally will allow cash-out refinancing equal to 80 percent of your equity. They will see a property value of $276,000 and subtract 20 percent ($55,200). That will leave $220,800. This money will be used to first repay the existing loan of $87,440. The balance – $133,360 – represents the cash available to the borrower.

With some program, you might do better. The VA allows qualified borrowers to refinance up to 100 percent of their equity while the FHA will go to 85 percent. However, these programs come with various charges and insurance costs that many borrowers with equity will want to avoid.

Cash-out refinance to buy another home

With cash-out refinancing, you can use the equity in your home for many things — but not for all things. For instance, you might use the money to pay for college tuition or to purchase a business.

In terms of real estate, you can use real estate equity to immediately buy a second home or to purchase an investment property. However, with cash-out refinancing or a home equity line of credit (a HELOC). you generally cannot use such funds to instantly buy a replacement home.

Related: 4 alternatives to a cash-out refinance

How come? There’s no restriction on the use of cash-out funds. As long as you pay it back, you can use the money as you please. However, cash-out refinancing and HELOCs generally have a clause which says you expect to remain in the property for at least a year.

This means you cannot get a check at closing and buy a replacement home the following week. That would be a violation of the mortgage terms. You don’t want to do that. Violate the rules, and the lender has the right to call the loan, to demand immediate repayment. For details and specifics speak with lenders.

HELOCs

You can certainly use a HELOC to pull equity out of a home. There are typically few up-front costs. It’s like a credit card. During the first few years of the loan term, you can take money out and put it back.

Related: Need money? A 2018 HELOC could be your solution

However, HELOC have several drawbacks. First, the interest rate is likely to be adjustable rather than fixed. Second, the interest rate will be higher than a typical first mortgage. How much higher depends on your credit, the amount borrowed, location and equity. Third, you have to watch HELOC balances to avoid steep monthly costs.

HELOCs are typically structured with two phases — a drawing phase, in which you pay interest only on what you use, and a repayment period, in which you must repay the balance over the remaining term of the loan. If you have a big HELOC balance, the result can be large monthly repayment costs, a shock to some borrowers.

Bridge loans

While cash-out refinancing and HELOCs may not be structured to help with the purchase of a replacement home, that’s not the case with bridge loans. A “bridge” loan is specifically designed to help you move equity from one residence to the next.

Related: Bridge loans (finance your housing transition)

The great attraction of a bridge loan is that it’s intended to be short-term financing. It might be outstanding for just a few months. You don’t have to make monthly payments.

There are also downsides. The interest rate is likely to be high. Maybe 2 percent above typical mortgage rates. Also, there can be a lot of up-front fees.

But, still, a bridge loan will do the job if you want to purchase a replacement home. When you sell your current residence, the bridge loan will be paid off at closing. The cost does not carry over to the new property.

Verify your new rate (Oct 23rd, 2018)