Cash Out Refinance
A cash-out refinance lets you access your home’s equity for major expenses or debt consolidation, while possibly lowering your interest rate. Discover how this option offers financial flexibility for your goals.
What is a cash out refinance?
A cash-out refinance allows homeowners to leverage the equity they’ve built in their property to access cash for various financial needs. This type of refinancing involves replacing your current mortgage with a new, larger one and taking the difference in cash. It’s a versatile option for those looking to consolidate debt, fund home improvements, or cover significant expenses such as education or medical bills.
How does a cash out refinance work?
Assess Your Equity
Your home equity is the difference between your home’s current market value and the amount you still owe on your mortgage. To qualify for a cash-out refinance, you’ll need to have sufficient equity, typically at least 20%.
New Mortgage Amount
With a cash-out refinance, you’ll take out a new mortgage for a larger amount than what you currently owe. For example, if your home is worth $300,000 and you owe $200,000, you could refinance for $250,000, receiving the $50,000 difference in cash.
Use the Cash
The cash you receive can be used for various purposes, including home renovations, debt consolidation, or any other financial needs. It’s important to use this resource wisely to ensure long-term financial stability.
Benefits of a cash out refinance
Lower interest rates
Refinancing could potentially lower your interest rate compared to high-interest debts, like credit cards.
Single monthly payment
Consolidate debts into a single, manageable payment.
Tax benefits
If the funds are used for home improvements, the interest may be tax deductible. Always consult a tax professional for specific advice.
Process of a cash out refinance
Understanding the steps involved in a cash-out refinance can help you navigate the process smoothly and make informed decisions.
Determine your financial goals
Identify what you want to achieve with the cash-out refinance. Whether it’s home improvements, debt consolidation, or covering educational expenses, knowing your goals will guide your decision.
Check your home equity
Ensure you have enough equity in your home to qualify. Typically, lenders require at least 20% equity. This means if your home is valued at $300,000, you should owe no more than $240,000.
Apply for the refinance
To get started with your refinance, you’ll need to submit an application. You’ll be required to provide documentation similar to the initial mortgage process, including proof of income, credit score, and information about your current mortgage.
Get an appraisal
Your lender will require a home appraisal to determine your homes current market value. This appraisal helps ensure you have enough equity to qualify for the cash-out refinance.
Underwriting and approval
The underwriter will review your full application, financial information and the appraisal report to determine if you qualify for a loan. If the criteria is met, your loan will be approved, and you’ll move forward to closing.
Closing and Receiving Funds
At closing, you’ll sign the necessary paperwork to finalize the refinance. After closing, it typically takes a few days for the funds to be disbursed to your account
Manage Your New Mortgage
With your new mortgage in place, it’s essential to budget for the payments and make use of the cash in a way that aligns with your financial goals.
Cash Out Refinance FAQs
This will depend on the kind of type of FHA refinancing in which you are interested. For an FHA cash-out refinance, the home must be your principal residence and you must have occupied the residence for the 12 months prior to applying for the cash-out refinance and receiving a case number assignment. You must also be in good standing with your mortgage payments for the duration of the time at your property. Another option is the FHA Streamline Refinance, which has more stringent guidelines but aims to simplify the cash-out refinance process.
If you are using the cash you received in your cash-out refinance to improve your home, such as adding a room or similar enhancement, the entire amount will still count as mortgage debt and the interest on the cash-out portion may be tax deductible. If you use the cash for something like a vacation or college loan, you may not be able to treat that interest as mortgage debt and it will not be tax deductible. It is important to discuss these distinctions with a tax accountant to clarify the qualifications.
A conventional cash-out refinance can be used on second homes, rentals and investment properties, but the property usually has to have been owned for at least six months. Loan limits vary from state to state and are dependent on the how many units are in the home that is being refinanced. Conventional loans with as little as 5% equity are eligible for refinancing, but will require private mortgage insurance (PMI), which is an added expense. Borrowers with a conventional mortgage and 20% equity are not required to have PMI.
After waiting the required period of time to apply, and verifying that interest rates are favorable, an FHA cash-out refinance can be used to lower monthly bills or add improvements to your home, just like a cash-out refinance of a conventional loan. However, many homeowners with FHA mortgages will choose to refinance to a conventional mortgage to eliminate the cost of the mortgage insurance required with FHA loans. Homeowners with 78% of equity in their homes may also be able to lower PMI payments when refinancing to a conventional loan. You must make sure you have the money for closing costs associated with refinancing to a conventional loan, which can be between 1.5% and 3% of the loan amount.
Yes, if you have a conventional mortgage you can use cash-out refinance for rental or investment properties. FHA and VA loans are only eligible for cash-out refinance if they are for your primary residence. Under current terms, USDA loans do not allow borrowers to use a cash-out refinance.
A good way to think about your ROI (Return on Investment) on a mortgage refinance is to calculate the monthly savings from a lower interest rate or reduced monthly payment, then divide that figure by the closing costs associated with the refinance to determine how long it will take to recoup those costs. Additionally, consider the long-term benefits, such as interest savings over the life of the loan or the potential for increased cash flow if you refinance to a lower rate or a shorter term. Here’s a simple formula to guide you:
- Calculate Monthly Savings: Subtract your new monthly payment from your current payment.
- Total Closing Costs: Add up all fees associated with the refinance.
- Break-Even Point: Divide the total closing costs by the monthly savings to find out how many months it will take to recoup the costs.
For example, if you save $200 a month on your mortgage and your closing costs are $4,000, your break-even point would be:
Break-Even Point =
Total Closing Costs
Monthly Savings
=
4,000
200
= 20 months
Additional Resources
Buyer’s Market or Seller’s Market? 10 Key Indicators Every Agent Should Track
Beyond the List Price: Understanding the True Cost of Homeownership
How to Help Clients Understand & Adapt to Market Shifts
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