What is a Cash Out Refinance Program?
Cash-out refinancing involves securing a new mortgage that exceeds the remaining balance on the previous loan, enabling you to receive the surplus amount in cash.
Cash Out Refinance Program
The cash-out refinance loan is a very popular home refinancing program that enable borrowers to tap their equity to receive money back in their mortgage. Typically, cash-out refinance rates tend to be lower than rates for home equity loans, although they may entail higher closing costs and fees.
Consequently, if you require a relatively modest sum, a home equity loan may be the more suitable choice. For larger sums, a cash-out refinance could be a viable option. The precise decision hinges on your available home equity, the desired loan amount, and your capacity to manage monthly payments.
What Is a Cash-Out Refinance Mortgage?
A cash-out refinance allows you to tap into your home equity by replacing your existing mortgage with a new one that carries a higher loan amount than your current balance. Upon loan closure, you receive funds that can be utilized for various purposes.
Is a Cash Out Refinance a Good Choice for You?
While there isn’t a definitive answer, contemplating a cash-out refinance might be prudent if:
You need to cover a significant expense and seek alternatives to higher-interest loans or credit cards. You possess sufficient available equity to facilitate the cash-out option.
When considering a cash-out refinance, it’s crucial to assess the utility of the funds against the time required to repay the loan. Take into account the following aspects:
- Remaining years on your current loan term.
- Duration of the new loan term.
- Current cash out interest rates.
- Required cash amount.
- Monthly payment obligations.
- Total lending costs.
- Break-even point.
To assist in answering these questions and determining whether a cash-out refinance aligns with your long-term financial objectives, reach out to several mortgage lenders that specialize in cash out refinancing.
What Are Cash Out Refinance Requirements?
The Federal Reserve has increased interest rates 11 times between 2022 and the end of 2023 to fight inflation. This made taking out almost any kind of loan more expensive – from mortgages to car loans to credit cards. Higher rates also made it more costly for current homeowners to refinance their mortgages.
For many people, the higher rates discouraged people from refinancing their mortgages; it is estimated that 80% of current homeowners have a rate of 5% or less. So, refinancing and pulling out cash would mean you would have a higher mortgage.
That said, it’s now 2024, and it is possible that rates could start to drop again. If so, more people may consider doing a cash-out refinance. But even if they don’t drop, don’t worry! Another option is to get a home equity line or credit (HELOC), which we describe later in this article.
Why Would You Do A Cash-Out Refinance in 2024?
There are several reasons that homeowners consider doing a cash-out refinance. First, you probably want to get a lower interest rate. If you have an 8% mortgage, it could make sense to get a new first mortgage at 7% and pull out cash. You could use some of your cash equity for paying off high-interest credit cards, home renovations, and more. A cash-out refinance allows you to swap your mortgage for a new one with a lower rate and for a higher amount (you take the additional amount in cash).
As we noted above, if you have a lower mortgage than current rates, you might not want to do a cash-out refinance. But there is a possibility that rates will drop in 2024. The Fed has said that it may reduce rates three times this year, which could lead to 30-year mortgage rates falling to 6% or even less. If you closed your mortgage loan in 2022 or 2023, it may make sense to do a cash-out refinance this year when rates go down.
You also may want to do a cash-out refinance this year if you have an adjustable-rate mortgage. These loans have fixed rates for a few years, then adjust. This can make it harder to follow a budget and may give you financial stress.
A cash-out refinance also may have tax-deductible interest, depending on whether you use the money for home renovations. The same is true for HELOCs that we describe below. But if you use the cash equity for anything other than home improvements, the interest is no longer tax deductible.
It may take 30 to 60 days to close a cash-out refinance loan after you apply.
Requirements for A Cash-Out Refinancing
If you decide that doing a cash-out refinance is a smart move, you need to understand what the requirements are. The requirements for this loan will vary by lender, but these are the general standards:
• At least 20% equity in your home. If you put down around 20% to buy the property, you may qualify within a few months of buying the home.
• A new home appraisal to verify what your home is worth.
• A credit score of 620 to 640, but higher scores mean a lower rate.
• Debt-to-income of 43% or less.
• LTV ratio of 80% or less.
The requirements above are for conventional cash-out refinances. If you want to do an FHA cash-out refinance, you can borrow up to 80% of the home’s value, and you will need to pay upfront fees that are rolled into the loan. There also is mortgage insurance required regardless of how much equity you have. Most FHA cash-out refinances require a 600 minimum credit score and the rates are competitive with conventional rates.
Cash-Out Refinance Example
Let’s assume you decide that a cash-out refi works for your finances. Suppose your home is valued at $300,000 and you have a $100,000 loan balance. This means you have $200,000 in equity.
Generally, you can borrow up to 80% of the home’s value. In this example, multiply $300,000 by .80, giving you a maximum loan of $240,000. You would take $240,000 and subtract the $100,000 you owe, giving you a potential of $140,000 in cash. Keep in mind that you would have a higher loan balance, and your payment could increase, even with a lower rate.
Most lenders will not let you take out more than 80% or 85% of your home’s value. This is considered too high of a risk for the lender. Most loan providers want the homeowner to have more skin in the game to reduce the number of defaults.
Should You Do A Cash-Out Refinance Or HELOC?
Another option to consider this year is a home equity line of credit or HELOC. A cash-out refinance is for your first mortgage and it replaces your current mortgage with a new one. A HELOC is a type home equity loan, meaning it leaves the first loan in place and borrows from your equity.
Why would you consider a HELOC instead of a cash-out refinance in 2024? After all, a cash-out refinance usually offers a lower rate than a second mortgage. The reason is that most people who have first mortgages today have lower rates than current ones. If you got a first mortgage in 2020 or 2021, your rate is probably much lower than current rates. Rates in 2020 were 3% or lower, and current rates in 2024 are around 7%. There is little reason to do a cash-out refinance if you will have a much higher interest rate.
A better option in this case is to get a HELOC that leaves the first mortgage alone. A HELOC is a cash out loan that has a higher rate than a first mortgage, but it’s still much lower than credit cards and other unsecured debt. A line of credit has a draw period of 10 years usually where you pay interest only. Then, you start to pay back principal, too.
A HELOC does not give you a lump of cash as a cash-out refinance does. You get a line of credit that is similar to a credit card. You can draw as much money as you want, up to your credit line. You only pay interest on money you have withdrawn.
Another factor with a HELOC is the rate is variable. This is important because in recent months, the Federal Reserve has indicated that it may not hike interest rates further to fight inflation. There even could be rate cuts in 2024 and beyond, so there’s a chance the HELOC rate could go down in future years.
A home equity credit line may take less time to close than a cash-out refinance, but it depends on the lender and your credit profile.
Last, a home equity line has a shorter term than a cash-out refinance, so the payments may be higher, depending on how much money you borrow.
A cash-out refinance is a smart way to get a lower rate and the cash you need in certain situations. If your new interest rate will be 1% or more less than your current rate, doing a cash-out refinance may be the right move. The qualifications for a cash-out refinance vary according to how much you take out and your credit profile.
If you won’t get a lower interest rate with a cash-out refinance, the other option is to do a HELOC. Both will get you the cash you need to pay off credit cards, pay for college, or renovate your home.
The only way to know if a cash-out refinance or HELOC is better for you is to go over the options with a loan adviser. For information about your loan options, please contact us today.
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