Everything You Need to Know About a Cash-Out Refinance
A cash-out refinance is a way for you to pull money out of the equity you have in your house. This new mortgage replaces your existing mortgage with an amount that’s higher than what you presently owe. The difference between the two is cash that comes to you, minus closing costs. Many homeowners use this money to do home improvements, consolidate higher interest debt, and/or meet other financial obligations.
Cash-out refinances are similar to other types of mortgages in that they are available as either fixed or adjustable interest rates, as well as a variety of different loan terms.
It’s also important to note that when you refinance your existing mortgage, you’ll be subject to most of the same underwriting criteria as when you purchased your home. So, this means you’ll need to:
- Prove that you can make higher monthly payments
- Have a debt-to-income ratio (DTI) below 43%
In addition, you’ll need to provide supporting documentation that includes:
- Proof of income via W2’s, 1099’s, retirement statements, bank statements and/or tax returns
- A certain amount of reserves in the bank, which will vary from lender to lender
The Top 3 Reasons Why Homeowners Refinance and Pull Equity From Their Homes
There are numerous reasons why homeowners choose cash-out refinances. Sometimes, they want to give their homes facelifts so that they can then turn around and list them for sale at a higher price. While this strategy can — and does — work when executed properly, if you’re thinking about going this route, be sure to do proper research to ensure that you’re going to get a good return on your investment.
Other homeowners refinance their existing mortgages to consolidate higher-interest debts, like credit cards, personal loans, and auto loans. By rolling higher interest debts into the mortgage, they can potentially:
- Save on their total expenses each month
- Write-off more mortgage interest on their tax returns annually, since a certain percentage of mortgage interest is deductible and the loan amount will be higher. Be sure to speak with your tax professional first, though, because laws and circumstances change.
And some homeowners will even use a cash-out refinance to purchase cars, motorcycles, boats, and other big ticket items since mortgage interest rates are still usually lower than many other types of bank loans.
The Costs of a Cash-Out Refinance
Much like if you’re simply refinancing your mortgage for a lower interest rate, there will be closing costs associated with a cash-out refinance, which on average will range between 3-6% of the total mortgage amount.
It’s important to carefully consider these closing costs when making a final decision whether a cash-out refinance makes financial sense for you, particularly if you’re:
- Planning on moving in the next few years, since you may not be in the house long enough to recoup them
- Consolidating debt, since your potential savings might not be worth the cost
The Benefits of a Cash-Out Refinance
Some of the benefits of a cash-out refinance can include:
- Access to cash quickly
- Lower interest rate: In comparison with a home equity line of credit (HELOC), the interest rate on a cash-out refinance is traditionally lower.
- Debt consolidation: As mentioned above, using funds from a cash-out refinance to consolidate higher-interest installment loans and revolving credit accounts can save you money on your monthly expenses in the short-term, as well as save you a tremendous amount in interest accrual in the long-term.
- A higher tax deduction: A higher mortgage amount means more interest accrues on it. Since a percentage of the mortgage interest you pay could end up being a tax deduction, you could be able to write off a larger amount. Again, please speak with a tax professional or financial advisor to find out for sure.
- Better credit scores: Paying off other debts in their entirety can dramatically improve your credit scores. It also reduces your credit utilization ratio, which can also assist in increasing your credit scores.
The Drawbacks of Cash-Out Finance
While oftentimes the positives of mortgage refinancing outweigh the negatives, it’s important to keep the following things in mind:
- You might not qualify for a cash-out refinance. In order to qualify, you’ll need to meet minimum credit score requirements, which will vary from lender to lender, as well as loan type (so, for example, FHA vs conventional).
- You will need to have owned your home for at least a year, and/or have put down a sizable down payment.
- Loan-to-value ratios (LTV) — the mortgage amount you have left to pay divided by your property’s appraised value — typically need to be below 80%. If you don’t have a ton of equity in your home, you likely won’t qualify for a cash-out refinance.
- It could start a precedent for bad credit habits if you find yourself repeatedly refinancing your home to consolidate debts. This might also make you careless with your spending habits, particularly those related to your credit card.
If you’re thinking about renovations, remodeling and/or debt consolidation, a cash-out refinance may be the perfect option for your needs, provided you qualify.
To learn more about your options, as well as qualifying criteria, contact the mortgage experts at Embrace Home Loans today. With over 35 years of experience, we’re one of the nation’s top full-service mortgage lenders, and look forward to speaking with you!