Question: We want cash-out refinancing. The value of our home has increased significantly in the past five years. We want to now get a cash-out refinance but worry that rising mortgage rates will make new financing too expensive. Our home is now worth $500,000, our current mortgage balance is $200,000. Can we refinance for $400,000? If so, what’s the best approach?
Answer: The idea of “rising” mortgage rates is very curious. No one wants to pay more for real estate financing but the hard fact is that mortgage rates have gone up. According to Freddie Mac mortgage rates for 30-year fixed-rate financing reached 4.65 percent for the week of September 20th. That’s up from 3.83 percent a year earlier, a significant difference.
We know that today’s rates are higher than in the recent past. What we don’t acknowledge is that mortgage rates during the past decade have been historically low. We have become accustomed to bargain-basement rates, knowing all along that the good times can’t possibly last.
Mortgage rates & history
Given a choice of mortgage financing at 3.83 percent or 4.65 percent everyone will choose the lower rate. But the lower rate no longer exists. It’s history. What does exist is the best rate you can find today. The good news is that today’s rates are STILL cheap by historic standards. If you look at mortgage rates between 1971 and August the average interest level was 8.16 percent according to Freddie Mac.
The question raised by higher rates is whether or not they’re affordable. You have to look at the numbers to see if your financial situation will allow you to borrow more. For example, a $100,000 mortgage at 3.83 percent has a monthly cost of $467.67 for principal and interest. Bump the mortgage rate to 4.65 percent and the monthly payment increases to $515.64. That’s a difference of $47.97 per month.
Going back to your question you have property with the fair market value of $500,000. You currently have an outstanding loan valued at $200,000 and you seek to refinance the property for $400,000.
A number of refinancing choices are available assuming that you qualify.
Full cash-out refinance
You might simply get a brand-new loan for $400,000 and pay off your existing debt at settlement. This will leave you with $200,000 in cash plus closing costs. With an FHA loan you could finance as much as 85 percent of the property’s value or $425,000. If you are a VA qualified borrower then 100 percent financing is available. With conventional mortgage programs you will generally be able to get as much as 80 percent coverage. In your situation a conventional refinancing would provide the $400,000 that you want but with a loan that will not require private mortgage insurance because you have 20 percent equity.
A full refinance means the end of your current mortgage and it may well be that the loan you now have is a very low interest rate. If you don’t want to lose that interest rate that it might make sense to consider a second loan or a home equity line of credit (HELOC). In either case your current mortgage will continue to exist, undisturbed by the new financing.
If affordability is an issue then you likely want the longest possible second mortgage. The longer the loan term the smaller the required monthly payment. There are second mortgages available with loan terms as long as 30 years.
Second loans typically have a higher interest rate when compared with first mortgages. That’s because they represent more risk to the lender – if everything goes wrong and the property must be foreclosed then all proceeds from the auction sale are paid to the first lienholder. Any money left over, if there is any money left over, then goes to the second lienholder. As with all forms of real estate financing it will pay to shop around for the best rates and terms.
Consider a HELOC
Rather than a full-blown second mortgage maybe what will work best in your situation is a home equity line of credit or HELOC. A HELOC is essentially a line-of-credit secured by your house. There might be a 10-year “draw” period when you can take money out and put money back just like a credit card. Then there might be a 10- or 20-year “repayment” period. During the second phase you must make required monthly payments to pay off the debt, just like a regular mortgage. No withdrawals are allowed.
The worry with a HELOC is that because the repayment period is relatively short monthly payments can be large. If you owe $75,000 at 6 percent at the end of the draw period and must repay over 10 years then the monthly cost for principal and interest will be $832.65. From many households that’s a large amount, and maybe unaffordable.
For more information regarding cash-out refinancing options speak with loan officers. Be sure to take a careful look at interest rates, repayment terms, and monthly costs.