What is Cash out refinancing?
A cash-out refinance gives you the chance to turn your home equity into a significant cash sum. By taking out a larger loan than what you currently owe on your mortgage, you can pay off the original loan and retain the extra cash. This money can be used for a variety of purposes, including paying off credit card bills, updating an old kitchen, or covering major expenses like college fees or a business investment. The decision on how to use the funds is completely up to you.
Key details about cash-out refinances
→ You need to have enough home equity to use as leverage and typically, the ability to manage a higher monthly payment
→ The finalizing expenses will be greater and the interest rate will exceed that of a simple refinance without any cash withdrawal
→ The withdrawn cash can be employed to pay off other liabilities, reduce your monthly expenses, or fulfill another financial goal.
A cash-out refinance is a method where you take a new mortgage to pay off your existing home loan and get a significant amount of money in return. The cash you obtain is the difference between your new loan and the balance of your previous one. It's important to understand that the sum you can borrow is tied to your home's equity, and you can't borrow the full equity.
For instance, consider your house is valued at $450,000, and the balance you owe is $300,000. This gives you a home equity of $150,000. However, the majority of cash-out refinance plans only permit you to borrow up to 80% of your home's value. This implies you could only borrow up to $60,000 from your total equity of $150,000.
With a cash-out refinance, you're taking on more debt than you currently have, so lenders will thoroughly examine your income, assets, and credit history to confirm you can handle the increased monthly payments. Usually, a cash-out refinance leads to higher monthly payments, although if interest rates have drastically dropped since your original loan, your mortgage payments might decrease.
In most cases, a home appraisal is required and has been the conventional way of determining your home's value for many years. In this method, a real estate appraiser compares your property to similar ones that have recently sold in your area and provides an estimated value. However, from April 15, 2023, you may have alternative methods to determine your home's value, such as:
Generally, lenders allow you to borrow up to 80% of your home's value, also referred to as your maximum loan-to-value (LTV) ratio, which shows the percentage of your home's value you're borrowing. However, eligible military borrowers may be able to borrow up to 90% of their home's value through a VA cash-out refinance.
By comparing rates from three to five lenders, you could potentially save a substantial amount of money in the long run.
The lender will calculate your total cash out by subtracting your current mortgage balance and any closing costs you have to pay from the loan amount.
If you decide to refinance, ensure that any new loan you're considering will truly benefit you financially, and aligns with how long you plan to stay in your home.
To find the best refinance rate, it's recommended to shop around and consider factors other than just interest rates when choosing a refinancing loan. This includes checking your credit reports and scores, gathering quotes or loan estimates from multiple mortgage lenders, comparing APRs instead of just interest rates, reviewing the "Projected Payments" section of your loan estimate, and budgeting enough cash reserves to cover your refinance closing costs.
Mortgage refinance rates usually fluctuate in sync with purchase mortgage rates, albeit being slightly more costly. However, refinance rates vary from lender to lender, which is why it's crucial to shop around and find a rate that's competitive enough to replace your current mortgage rate.
Refinancing your mortgage means obtaining a new home loan to replace an existing one. A mortgage refinance can help you save money by reducing your interest rate, shortening your loan term, and providing you with extra funds to put toward your financial goals.
However, before you proceed, ensure that you've prepared yourself for a successful refinance by having a goal and a plan.
The pros of refinancing include the possibility of getting a lower interest rate, changing to a shorter loan term, getting a lower monthly payment, reducing or eliminating your private mortgage insurance if your home value has increased, and accessing a large lump sum of cash that can be put toward other financial goals. The cons include having to pay refinance closing costs, pushing out your loan payoff date if you refinance into a loan with the same term as your existing loan, potentially stretching your budget too far if you refinance into a shorter loan term, not breaking even if you move or sell the home too quickly, and reducing the amount of equity you have in your home if you borrow against it when refinancing.
The most common types of mortgage refinance options are offered by conventional lenders, as well as lenders approved by the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA).
As of May 1, 2023, conventional loan borrowers with certain characteristics may face additional charges or rate increases.
To refinance your mortgage, determine your refinancing "why", gather information about your home's value, apply with at least three to five refinance lenders, lock in your mortgage rate, and close on your refinance.
You should refinance when you're sure to see a long-term financial benefit. You might refinance to get rid of private or FHA mortgage insurance, shorten your loan term, or for many other reasons, but you should only do so if you understand when you'll break even on the refinance and how the changes in your payment amount will affect your monthly budget.
