A cash out refinance is once again a real possibility for many homeowners who finally have appreciating property values. Places like Phoenix, Arizona, Las Vegas, Nevada, and Los Angeles, California have seen tremendous price appreciation.
As property values climb, cash out refinances become feasible.
What is a Cash Out Refinance?
First of all, a no-cash out loan, also known as a “rate and term” refinance simply improves the rate and/or term of a loan but does not provide any cash back to the borrower.
A cash out refinance, as the name indicates, gives cash back to the borrower – or pays of non-mortgage debt. This is done simply by opening up a bigger mortgage balance than you currently owe.
Some conventional lenders allow a cash out refinance up to 90 percent of the value of the home while some states limit by law the cash out refinance loan be no greater than 80 percent of the appraised value. (The exception would be FHA cash out and VA cash out refinances).
How does a Cash Out Refinance Work?
Here’s how a cash out refinance works. The lender orders an appraisal to determine value. Say the property appraisal reports the property is worth $500,000. Now say the current mortgage on the house has a balance of $275,000 and cash out limit is 80 percent of the value, the calculation is:
$500,000 X .80 = $400,000. When subtracting the existing loan balance of $275,000, the available cash to the borrower is $400,000 – $275,000 = $125,000, less any closing costs.
Interest rates on cash out loans are typically a bit higher than refinances pulling no cash out and can be higher or lower depending upon the final loan-to-value number. For example, if a cash out refinance loan is 65 percent of the value of the property, the interest rate will be lower than a cash out refinance with a loan-to-value of 80 percent.
What can you do with Cash Out Loan Proceeds?
So what can you do with your newfound cash? Pretty much anything. You can take a trip with it, remodel your kitchen or pay for a child’s college tuition. There are no restrictions on what you can do with the funds. However, understand that you are pulling out equity in your home and you will pay interest on that withdrawal.
A common use of cash out funds is to pay off a car loan. Say that a homeowner has an automobile loan of $20,000 and a rate of 7.00 percent, fixed for five years. The monthly payment for that loan is just under $400.
Let’s now look at a homeowner with a $200,000 loan balance on a 30 year mortgage with a 5.00 percent rate, refinancing to a 4.00 percent, 30 year loan and pulling out $20,000 to pay off the car, eliminating the car payment.
The borrower replaced the $400 car payment with a $96 increase in their mortgage payment, saving more than $300 per month. Borrowers can do the same with any outstanding loan balance including paying off high interest credit cards and other installment debt.
But cash out refinancing isn’t always a no-brainer. Using this example, yes, the borrower reduced the monthly payment by $300 and eliminated a car payment but now that additional $20,000 is spread out over 30 years, not five. And paying off credit card debt? Yes, eliminating debt and lowering monthly payments is always a good thing but 1) debt isn’t eliminated, just transferred to the house and 2) paying off high interest credit card debt sounds reasonable as long as the borrower doesn’t go back out and charge up those very same cards.
Cash Out Refinance: Do Your Homework
Getting a cash out refinance should, hopefully, can be combined with lowering your interest rate or loan term. There can be closing costs involved and the loan term may be extended so it may be an expensive way of getting cash.
If your current loan has a low rate and you still want to pull cash out, you might want to consider a home equity line of credit instead. Many local banks offer them.
However, if you are considering a refinance or you’re in the middle of a refinance application right now, speak with your loan officer to see what the impact might be if you pulled out a little extra cash at the same time you were lowering your interest rate. Rates are great, and you can use the funds for anything you want.
HARP and Cash Out Refinancing
You can’t combine a cash out refinance with HARP. Home Affordable Refinance Program loans are meant to simply reduce your rate or loan term, and are for homes that lack equity.
You should only consider a cash out refinance if you have significant equity in your home and a real need for a substantial amount of cash.
I’m Ready to Apply
Cash-out refinance rates are low, and homeowners are putting their home equity to work.