A popular option for homeowners who are looking for cash when mortgage rates are low, a cash-out refinance replaces your existing mortgage with a larger loan, providing the difference between your old mortgage and the new (larger) refinancing amount to you in cash. Here’s what you need to know about a cash-out refinance.
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Who qualifies for cash-out refinances?
Like most types of home financing, your lender will set a maximum amount of cash you’re able to take out of your home based on your loan-to-value ratio – or said differently, how much of your home equity you own. The max LTV ratio for most lenders is 80%, which means you’d need to already own more than 20% of your home equity in order to increase your mortgage balance through a cash-out refinance.
Credit score minimums for cash-out refinances are generally lower than HELOCs and home equity loans, but because your new monthly payment will likely increase along with your higher loan amount, your lender may want reassurance that you’ll be able to manage a higher debt load. As a result, if your debt-to-income ratio is higher than 43%, your lender may impose additional restrictions or fees. Generally, lenders will not approve an application for a cash-out refinance if your total monthly housing payment exceeds 31% of your gross monthly income.
|Credit score min||580|
|DTI||Up to 60%||Up to 439p|
Is a cash-out refinance the best option for me?
If you’re in need of cash and believe you can lower the interest rate on your mortgage by refinancing, a cash-out refinance may be worth consideration – especially if you’re confident that you will stay in your home long enough to recoup the closing costs.
It’s also worth noting that if you’re using your cash-out funds to make substantial home improvements that will increase its value, you may be eligible for a tax deduction on your cash-out refinance interest payments.
When might a cash-out refinance not be a good option for me?
If you’re not confident that your home will increase in value over the course of your loan term, a cash-out refinance may not be your best option because you’d still be on the hook for the full balance of your new mortgage – even if your home sells for less.
The final cost of your cash-out refinance may also be affected by the amount of cash you take out of your home. If you need to borrow more than 80% of your home’s value, your lender will likely require you to take out private mortgage insurance, which will add to your monthly costs.
Finally, as with all home financing options, tread carefully if you’re using your cash-out refinance funding to pay off unsecured debt. Financial advisors generally recommend against replacing unsecured debt like credit card bills with secured debt like a cash-out refinance unless you have a solid plan to avoid future debt.
Home Equity Sharing vs. Cash-Out Refinancing
Homeowners refinance for any number of reasons. One typical situation is that the family needs a sizable amount of cash to take their next financial steps. The home becomes not only a living space, but an asset to use toward other family needs.
If you’re new to home refinancing, you’re probably wondering how home financing works! There are multiple refinancing options with different target results: lowering mortgage interest, tapping equity, or minimizing monthly payments. If you’re interested in accessing some of your home equity, take a look to learn whether cash-out refinancing or home equity sharing fits your plans best.
How Cash-Out Refinancing Works
A cash-out refinance loan replaces your current mortgage with a new loan that’s higher than the balance you owed before. The idea is you pay off your existing mortgage and have money left over to spend on other financial plans.
You need to have a certain amount of equity to make cash-out refinancing work. Generally, you don’t want to dip below 20% equity in your home. So if you have a home valued at $300,000, and your remaining mortgage balance is $170,000, the numbers could work out like this:
$130,000 equity – $60,000 (i.e., the 20% minimum equity balance you want to keep) = $70,000
So, $70,000 is a good idea of the maximum you’d plan to take from your equity in cash. Whatever amount you take gets added to the new loan in cash-out refinancing, so plan carefully so you only refinance to withdraw the equity you need.
Cash-out refinance benefits
Many of the benefits of cash-out refinancing revolve around getting a portion of your home equity in hand. Having funds to pay off or consolidate debt, make home renovations, or meet other goals can be a positive step for your family. But why go with cash-out refinancing over another approach to using home equity, like home equity sharing?
Depending on your plans, you may be eligible for a tax benefit. You can deduct mortgage interest on the first $750,000 of your home debt if you use home equity loan proceeds to buy, build, or make substantial improvements to your home. This is a change from tax laws prior to 2018, which set a $1.1 million limit and didn’t include the restrictions on how you spend the proceeds.
Cash-out refinancing downsides
Cash-out refinancing may be a good option if you’re planning to put money back into your home (and take advantage of any tax deductions). The main downside is that a poorly handled cash-out refinance can put your home at risk of foreclosure. It’s generally not a wise idea to satisfy unsecured debt, like credit card balances, by putting up your home as collateral. Other downsides include:
Closing costs: Refinancing comes with closing fees, which usually amount to 2-5% of the loan total. Borrowing $150,000 will cost you around $3,000-$7,500. Ask yourself whether you’ll stay in the home long enough to recoup that value.
Possible increased interest rate or fees: You agree to a new mortgage, with new terms. Read through your current mortgage details and the cash-out refinance terms thoroughly before you sign.
Private mortgage insurance costs: If you do need to borrow more than 80% of your home’s value, most lenders require you to pay for private mortgage insurance (PMI). In some cases, you may need to continue to pay for PMI even once you’re back over the 20% equity line.
Cashing out equity can help solve immediate problems. It’s important to work with a financial advisor to spot any strategies you can improve to avoid finding yourself in a difficult financial position again.
How RealtyGO Home Equity Sharing Works
Home equity sharing is a non-loan alternative to options like cash-out refinance. You work with a partnering business that essentially buys a share of your home’s future appreciated value. You get financing up front to represent the company’s share of your home equity. As your home grows in value, or even if the value drops, the amount you’ll need to pay back changes accordingly. So if you get $20,000 in financing and your home appreciates 20% in value, you’ll repay $24,000 to equal the principal plus the appreciated growth.
Benefits of home equity sharing with RealtyGO
Home equity sharing comes with several advantages that can help you build a financial plan that works for your family. Like cash-out refinancing, you get financing up front to use toward whatever you need. Other home sharing benefits include:
No monthly payments: Unlike a traditional loan, you don’t need to start repaying the principal right away. RealtyGO doesn’t classify as debt because we’re sharing a portion of your home, not just lending you cash. No monthly payments means you don’t need to rewrite your entire budget. The agreement won’t appear on your credit report, and it won’t count toward your debt-to-income ratio.
No interest: Loans accrue interest, and sometimes you need to pay a larger proportion of interest before you get to make a big dent in principal. Home equity sharing doesn’t operate on an interest-based model.
Risks are shared: When it comes to debt, lenders expect every dollar back (plus interest, of course!). If the housing market doesn’t go your way, too bad. You’re still on the hook for the full balance. Home equity sharing agreements work more like a true partnership, where both parties agree to share the wealth or take a loss together. That means if you borrow $20,000 and your home drops 10% in value, you’ll only repay $18,000.
Cons of home equity sharing
You’ve heard before that if something seems too good to be true, it probably is. It’s always smart to consider the potential downsides to any financial agreement before moving forward. Home equity sharing is no exception.
The main drawback to home equity sharing is that your final payment can end up being higher than the initial financing. As your property value increases, the share you repay the home equity partner goes up, too. If your local housing market booms, it’s possible you could end up repaying more than you would have with another financing option. Presumably, though, if your home value is assessed much higher, the idea is that you’d make more on a sale and keep your share of the extra value, too.
Considering that final repayment on home equity sharing can go down as well as up — meaning the financing company shares in your losses as well as gains — you may decide you’re okay with a possible increase from the initial financing. Talk with a financial advisor for professional advice on your best options.
Should You Get Cash-Out Refinancing or Home Equity Sharing?
How to finance your home is ultimately your decision. You know your situation, your financial habits, and how you feel about the risks and benefits. Your plans to sell your home or not, and how you feel about monthly payments versus repayment by end of term also influence your decision.
A few things to discuss with a financial professional before entering a home financing agreement are payment terms and backup plans. If you go with cash-out refinance without a strong plan in place to meet your new mortgage, you could face foreclosure. Check if the lender or financing company offers any kind of homeowner payment protection program if you fall on hard times and need flexibility on payments.
Consider the financing terms, too. High, long-term costs can cause payment difficulty. If it makes sense to choose an option with a shorter term, that could be a factor in which type of financing is best for you. Many cash-out refinance loans set payments on a 30-year term. RealtyGO’s home equity program sets the term at 10 years.
Home refinancing can be a smart option if you have sound plans for the money you pull from your home equity. Renovating to improve your home’s value or getting out of debt can put your funds to good work. The type of refinancing plan that makes most sense for you depends on your individual situation. Whether you choose cash-out refinancing or home equity sharing, using your equity wisely is the top priority.
Should You Refinance Your Home? Pros and Cons
When times get tumultuous, your first instinct is probably to shore up the most important pillars in your life. Home and family mean everything, especially in uncertain times. If you were considering refinancing your home, you may be wondering if now is the time to act quickly on that process, or put it on hold.
Refinancing is a financial move where you pay off an existing loan and replace it with a new loan that has more favorable terms. Lowering your interest, shortening your mortgage length, or changing from variable to fixed-rate mortgage are common reasons why people may refinance their mortgage. But it’s not always the right solution, or the right time. Read on to learn whether this might be a helpful next step for you.
The Truth About Refinancing Your Mortgage
Note: First off, refinancing in the next few months of 2020 may be especially challenging. Due to coronavirus worries, many banks are loaded with far more requests for loan assistance than usual. It may take longer to find a lender who’s available, or willing, to work with you. It’s also difficult to predict what will happen with interest rates. Interest has been on the low end of historical ranges in recent years, which is promising for refinance. But in light of the rapidly changing response to COVID-19, it’s extremely difficult to say for certain what the impact will be on financial markets in coming months.
Fans of refinancing a mortgage say you can lower your interest, build equity faster, and save money in the long term. The truth is, while refinancing can be a smart homeownership move in some cases, it also cuts into your finances in the short term. You need to weigh the disadvantage of paying money now (e.g., closing fees) against securing a better deal for your home in the long run.
Refinancing rule of thumb
Common guidance says refinancing is only worth it if you’re saving at least 1% on your interest rate, and preferably 2% or higher. Otherwise, closing costs and the hassle of the process can outweigh the benefits of a slightly lower rate.
In addition to reviewing interest rate savings, the rule of thumb says refinancing is only worthwhile if you’re planning to stay in your home long enough. Compare closing costs against the amount of money you could save annually to determine how long it will take to break even.
Should I refinance to a 15-year mortgage?
If you refinance from a 30-year loan to a 15-year loan, your monthly payments may stay the same or even increase, but the benefit is you’d own your home free and clear much sooner.
If this is your reason for refinancing, the guidance about comparing closing costs to monthly or annual savings might not make sense for you. Instead, you’d review how much you could save over the life of the loan by reducing the duration. You should also pay attention to how your monthly budget will change, and whether you have the finances in place to pay the new mortgage even if you face an unexpected loss in income.
Types of Refinancing
People refinance their homes for different reasons. Some homeowners are interested in lowering interest rates or changing the terms of their mortgage. Others refinance in hopes of cashing out part of their equity to use toward other goals. Different types of refinancing will appeal to different families, depending on their reason for refinancing.
# Rate and term refinance: The goal here is to trade your mortgage for one with a lower rate, terms that fit you better, or both. Changing terms might mean switching from a 15-year mortgage to 30 years (or vice versa), or changing between adjustable and fixed-rate terms.
# Cash-out refinance: You refinance the mortgage to a higher balance and withdraw some of the equity of your home. Because your loan total increases, your mortgage payments may increase (although you might be able to offset some of that if you get a lower interest rate). A cash-out refinance loan is different from a home equity loan because you’re still sticking with one mortgage loan, instead of adding an extra home equity loan.
# Cash-in refinance: In this case, homeowners bring extra cash to pay in more equity on the home. In addition to the usual rate-and-term reasons for refinancing, increasing equity might help you eliminate mortgage insurance payments or qualify for better rates. Make sure you have fully funded emergency savings accounts before considering this option.
# Streamlined refinancing: Refinancing can be a lengthy process requiring credit checks and a detailed look at your finances. Some homeowners may qualify for a streamlined process that waives some of the typical approval steps and shortens the underwriting process. Streamlined FHA loans are one of the most common options.
Pros of Refinancing
For many homeowners, their home represents one of their biggest sources of wealth, and their largest debt. Managing your mortgage wisely can make a significant impact on your financial health.
Benefits of refinancing mortgage
The benefits of refinancing your home loan include the following:
# Lower interest rate: This can save you hundreds of dollars per year.
# More stability: An adjustable rate may start lower than a fixed rate, but fluctuations can send it much higher. Refinancing to a fixed rate may give you more predictability and security.
# Additional cash access: If you choose a cash-out refinance, you’ll have extra cash available for your needs.
# Updated mortgage plan: Maybe you’re earning much more than expected, and you want to shorten your mortgage term and own your home outright sooner. Maybe you’ve decided slow and steady is better for your family, so you’ve prolonged the loan for lower monthly payments. In either case, refinancing can align your loan terms with the structure that best fits your family.
Is refinancing worth it?
Refinancing is a complicated process, and it comes with its own expenses. Refinancing can be a useful tool at the right time, but it won’t fit every situation.
Refinancing to save 0.5% interest, for example, is unlikely to be worth the effort. Closing costs are likely to wipe out too much of the amount you’d save. If you’d save 1%, some lenders would say it’s worth proceeding. Other financial experts may advise you to aim for at least 2% savings.
Your total savings depend on a variety of factors. Checking a refinancing calculator online can give you an estimate of how much you might be able to save. Refinancing a $200,000, 30-year mortgage after 5 years to lower interest rates by 1% (from 5% to 4%) could save over $9,000 in interest over the life of the loan. Monthly payments would also go down by nearly $200. Check numbers with a financial professional to decide what savings cutoff makes refinancing a smart financial move for you.
Cons of Refinancing
Refinancing is far from a magical solution to financial woes. Refinancing the wrong way, or for the wrong reasons, can be a serious mistake.
Dangers of refinancing mortgage
Keep these risks in mind before refinancing your home:
# Expensive: Closing costs can range from 2-6% of the loan amount. If you’re refinancing a $200,000 mortgage, that’s $4,000-12,000! Cutting down your available cash is risky because it leaves you in a more vulnerable position if another unexpected expense comes up.
# Potential for greater debt: Some homeowners choose cash-out refinancing so they can pay other debts with home equity funds. If you pay off your credit card debt with home equity, but then max your cards out again, you’ll be worse off than before.
# Pay more interest: If you refinance to lower monthly payments as much as possible, you may end up paying more interest. If you were halfway through a 30-year mortgage and refinance to a new 30-year loan, you’ll start over spending years at the outset paying mostly interest, rather than principal. Your monthly payments may drop, but the amount you spend on your home overall may go up.
Does refinancing hurt credit?
The credit inquiry for refinancing approval will ding a few points off your credit score temporarily. Resolving the original mortgage loan can also affect credit, because you’re replacing an older loan with a new one. These are fairly small impacts, though.
Cash-out refinancing has the biggest potential to harm your credit. For one, you’ll have a larger debt-to-income ratio. You also have cash burning a hole in your pocket. Without a firm plan, you might be tempted to splurge and rack up more debt.
Ultimately, the slight credit score dips that come with credit checks aren’t the most important factor to consider. Refinancing changes your debt profile and may give you cash that could lead to more debt. Your spending habits matter much more than a temporary ding from a credit inquiry.
Refinancing your mortgage is one method to reduce the amount you pay into your home. If you treat it as a management strategy, and not a bailout tool, and if you consult a trusted financial advisor, you’ve got the best chance of finding a refinancing deal that pays off.
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