What is a cash-out refinance?
Cash-out refinancing means that you will refinance your existing mortgage with a new mortgage for more than you owe on your house. You are then paid the difference between your current mortgage balance and home’s value. Given this, you will need to have equity already built up in your house. According to Freddie Mac’s 2019 Quarterly Refinance Statistics, “cash out” borrowers represent 83% of all conventional refinance loans, which is the highest share since the third quarter of 2007. Cash out refinances traditionally have higher interest rates due to having a higher loan amount and limit the amount of cash out you can take to 80-90% of your house’s equity. Other factors can also come into play as well such as if the home is a single family residence, the LTV (loan-to-value ratio) and even whether there is another loan on the property.
How much can I cash out from my refinance?
Given the fact that you can typically only take 80% of your home’s equity, here is a good example of the cash you can get from a cash out refinance:
Your current home is valued at $250,000 and you have a mortgage balance of $150,000. Now you can take out a mortgage balance of $200,000, getting $50,000 in cash to do what you want with it because the new loan is 80% of your home’s current value of $250,000.
The difference between a cash out refinance and traditional refinancing is that with the traditional refinance, you are just replacing your existing home loan with a new one with the same loan balance.
When to cash out refinance?
The best time to take a cash-out refinance is if mortgage rates are low and you can get a good interest rate on your new loan and can use the money in a way to potentially build more equity into your home. One way to do this would be for home renovations that can improve your home’s value. Another time to refinance is when you are using the money to consolidate your debt, as you can typically get a better interest rate through a cash out refinance than you could through a personal loan or credit card.
How long does a cash out refinance take?
A cash out refinance is typically faster than a HELOC or Home Equity Loan and could take at least 30 to 45 days, but each person’s individual timelines varies and depends on certain factors. Some factors lenders tend to take into consideration includes the verification of your personal information, as well as the speed of the lender you are getting your cash out refinance through. The cash out refinance process can be done online, but delays can occur due to documentation verification, such as income history or home value information. If you are proactive with all your paperwork and your lender is responsive, this process could be quicker. Another factor of approval time is your credit. Typically, the higher your credit score the faster you could be approved, as there will be less verification needed with lower credit scores or a limited credit history.
What do you typically need to apply for a cash out refinance?
Typically, you will need a credit score of 600 or higher depending on the lender
Proof of Income
Depending on the lender, you will need to provide your pay stubs and current tax forms like a W2 and 1099. Additionally, you may be asked to provide your bank statements and/or proof of additional income such as investments or rental income.
You will need to show proof of having a loan to value ratio of 75% or lower. To do this you may need to provide statements for your debts including student loans, auto loans, high-interest credit cards, other mortgage loans, etc.
Demonstrate that you had no late payments for the past 6 months
You will need to verify the value of your home via a home appraisal to truly understand the amount of cash you will be able to take out of your home.
Home Ownership Documents
You may be asked to provide proof of title insurance and/or mortgage statements.
Is a cash out refinance a good idea?
A cash out mortgage refinance is a good idea if you are able to both get a better a rate on your original mortgage and combine it with getting cash that can help pay for major expenses that can greatly improve one’s financial well-being. The most common uses of a cash out refinance include the following:
Lowering your current interest rate
The best reason to get a cash out refinance is the same as why most people do a traditional refinance and that’s to lower your interest cost while taking on a larger loan. This is when you can get a lower rate than on your original loan, depending on whether you qualify for a lower rate with lenders.
Homeowners can use cash out mortgage refinancing to make improvements to their home that could increase their home’s value. By using your home’s equity, you could get a better rate than other forms of financing which includes credit cards, home equity loans or personal loans, depending on the lender. Further, these home improvement projects could allow homeowners to deduct the mortgage interest from their taxes.
If you can reduce the interest rate of your primary mortgage and, in combination, take out money to pay down your high interest debt, a cash out refinance could make sense for you. Most likely, these high interest debts will be at an interest rate much higher than the interest you would get when refinancing your home.
If you have a kid that is looking to attend college, it could be a smart move to use your home’s equity to pay for their education rather than get a student loan where the rates may be much higher.
Do you pay taxes on the cash taken out of a cash out refinance?
Typically, you are allowed to deduct the interest paid on up to $1 million in mortgage debt on your primary or secondary home (or both combined) when refinancing as a couple and $500,000 as a single. If you are single and are taking money out of your home via a cash out refinance, you can deduct the interest on up to $500,000 if you use the money on home improvements or repairs.
However, if you are taking money out for something OTHER THAN home improvements and/or repairs, then it is no longer qualified as mortgage debt and looked at as a home equity loan for tax purposes. This means that the interest paid on this type of cash out refinance is only tax deductible up to a maximum of $100,000 for a couple and $50,000 for a single individual.
Here is a great example of how this works:
Person A: Owes $300,000 on their mortgage. Takes a Cash Out Refinance for $375,000 and uses that to improve their kitchen. The mortgage paid on the full $375,000 is tax deductible as they are below the limit of $500,000 for single homeowners.
Person B: Owes $300,000 on their mortgage. Takes a Cash Out Refinance for $375,000 and uses this to consolidate their outstanding credit card debt. They would only be able to deduct the mortgage interest on $50,000 of the new debt, but the $25,000 left over would NOT be tax deductible.
Are cash out refinance rates higher than traditional refinance rates?
Cash out refinance rates are no different than traditional refinance rates when offered by a common lender, but different factors can affect what rate you are offered for a refinance. The difference between the two lies in the fact that you will be tapping into your home’s equity to take out a larger loan in order to get cash, typically for a major expense.
What are the differences between a Cash Out Refinance and a Home Equity Loan and HELOC?
The big difference between a cash-out refinance loan and home equity loans is that a cash-out refinance takes your current mortgage and converts it into a larger mortgage, whereas other home equity loan options create a second mortgage on your home. A Home Equity Line of Credit (HELOC) acts as a second mortgage and allows you to withdraw the money you want as you need it and only repay the amount you borrow, while a cash out refinance is a lump sum.
Here are some key comparison points:
Cash Out Refinance allow you to borrow against 80% of your home’s value whereas HELOCs allow you to borrow up to 85% of your home’s value.
Amount you could get at closing
With a Cash Out Refi, you get a lump sum at closing (usually up to 45 days). With a HELOC, you get access to a line of credit that you can take out at your discretion (usually under 30 days).
Cash Out Refinances have closing costs that range from 2-5% depending on the lender. HELOCs, on the other hand, have little to no closing costs.
With a cash-out refinance, you can select your loan term, choosing among popular options such as a fixed-rate mortgage of 15 or 30 years or variable rate mortgage with a 5/1 ARM. Most HELOCs come with a draw period of up to 10 years.
In a nut shell, a cash out refinance may be better for you than a HELOC if you prefer the stability of a fixed monthly payment, what you save by refinancing outweighs refinancing fees and your current home loan has a higher rate than you could qualify for now, saving on interest. A HELOC is better if you want to stick with your current mortgage due to having a lower interest rate than you could get today, you like the flexibility of having a line of credit you can borrow against and you want to borrow against 85% of your home’s equity vs. 80% you would get with a cash out refinance.
Can you do a VA cash-out refinance?
If you meet the VA loan requirements, you could get a VA loan cash out refinance which would allow you to pocket up to 100% of your home’s value. The VA cash-out allows you to also receive cash at the closing of the loan and refinance a non-VA loan. Further, the VA cash out refinance, like all VA loans, requires no mortgage insurance.
Can you do a cash out refinance on rental or investment properties?
For an investor, a cash out refinance is a great tool. A cash out refinance can help you maximize the return on your investment to lower your monthly mortgage payment and increase your rental income or allow you to buy additional property. While this could be a great tool, there are rules and guidelines for cash out refinances on rental properties:
- The maximum loan-to-value is 75% for 1-unit properties and 70% for 2- to 4-unit properties. These maximums are lowered by 10% for adjustable rate mortgages. If listed for sale in the last 6 months the maximum LTV is 70%.
- The property can’t be listed for sale when applying.
- The property is not eligible if purchased with the last 6 months unless the new loan amount is no more than the original purchase price plus closing costs, no mortgage financing was used for the purchase, the seller didn’t have a pre-existing relationship or financial interest and the buyer has a final Closing Disclosure that shows the purchase price and other transaction details.
- These requirements all fall under the delayed financing rule.
Are there additional costs with a cash out refinance?
Just as with a traditional cash out refinance, you will pay closing costs. These costs are typically 2%-6% of the mortgage. For context, this will range from $5,000 to $15,000 on a $250,000 mortgage.
If you are looking to borrow more than 80% of your home’s value, you will also have to pay private mortgage insurance (PMI). This insurance typically costs anywhere from 0.55% to 2.25%. For context, PMI of 1% on a $250,000 mortgage would cost $2,500 per year.
Frequently Asked Questions (FAQ)
What is considered a good mortgage rate?
There are 2 types of mortgage rates – fixed and variable.
Fixed mortgage rates boast a set interest rate that never changes throughout the loan. A fixed-rate will protect you from unexpected increases in your monthly payments if interest rates in the market happen to rise. Even though the interest rates stay the same in a fixed mortgage, the terms can vary. A 30-year fixed mortgage will offer the lowest monthly payments, for example, but the cost will be higher overall because of interest payments. Your monthly payment will be higher the shorter the term, but the less you’ll spend on interest in the long haul.
Variable rates are also known as ARMs (adjustable-rate mortgages). These mortgage rates can change. Typically though, they begin lower than the average fixed-rate at the time and then rise as your loan matures. Variable rates do have a fixed period, though, in which the interest percentage you’ve agreed upon cannot increase. This period can last anywhere between 1 month and 10 years, depending on the agreement between the borrower and the lender.
While ARMs come with a ceiling, preventing the rate from passing a certain point, it’s crucial to take a look at what that ceiling is. Whether or not a rate is reasonable for you is incumbent on a variety of factors. While locking an excellent rate with a 5/1 ARM is a great way to save money in the long run, if you’re scraping by to make payments and you end up refinancing, you’ll end up with higher interest rates to get that lower monthly payment. Become familiar with your budget if you aren’t already so that you know what you can afford.
What external and internal factors affect mortgage rates?
5 significant external influences play a role in how mortgage rates are determined.
- Economic growth
- The Federal Reserve
- The housing market
- The bond market
In addition to these external factors, there are personal and other factors that will affect your rate, too, such as:
- Your credit
- Your job
- Your income
- Your down payment
- The home’s location and price
- The loan term and type
A lender takes into account the borrower and evaluates the risk of any loan they divvy out. They’ll adjust the mortgage rate accordingly based on how high they deem the chance to be. The riskier a borrower is, the higher the mortgage rate will be.
Should I lock my mortgage rate today?
Whether or not you lock in your mortgage rate today is a decision that should be weighed carefully, and it’s a difficult one to make. If you lock in your mortgage rate today, you run the risk of losing out on savings if the rates continue to go down. If you don’t lock in your rate, however, you could get stuck with higher payments if we’ve already reached the low and mortgage rates start to rise.
Minute rate differences can add up quickly throughout a lengthy loan. It’s safe to say, though, that mortgage rates right now are on the lower end, so even if the rate does go down a bit more, your lock-in rate today should still be reasonable. The essential piece in deciding whether or not to take advantage of current mortgage rates is to shop around.
What are the best ways to shop for a mortgage rate?
The first step is to know your credit. Your credit score is what helps the lender determine if you qualify for a loan and what the interest rates will be. Your terms will be better with a higher credit score. Take the time to scrutinize your credit reports and correct any errors. If there’s anything to be explained, it’s best to be upfront about it.
Next, consider the different mortgage types and their refinancing options. Even though you’ll pay more interest in the long run, there’s nothing wrong with taking out a 30-year mortgage at a fixed rate that you know you can afford. On the flip side, if you feel comfortable taking advantage of a variable rate and think you can pay off the majority of your mortgage before those rates rise, find out what your options are.
Contact several lenders in your process and take the time to shop around. Add in any additional costs, such as appraisal, application, loan-origination, broker fees, underwriting, and settlement costs.
Don’t be afraid to negotiate and get everything in writing. If you’re happy with a proposed offer, request a lock-in (rate-lock) that details the agreed-upon rate, the number of points (if at all) paid, and the period of the loan. The lender might charge you a nonrefundable fee for locking in your terms, but it’s worth the payment considering some of the bumps in the road that can occur along the way to getting approved.
Are rising interest rates good or bad?
Higher interest rates aren’t usually good. Higher interest rates can change the cost of borrowing money , saving money and much more. However, contrary to popular belief, rising interest rates aren’t all bad. Rising interest rates can mean different things for different people. As a consumer, rising interest rates are not good. This means that you would be paying more money towards interest and keeping less of your money in your wallet. Usually for a consumer, having the lowest interest rate is the best, especially when it applies to a big purchase like a mortgage. However, for the nation as a whole, rising interest rates are a good thing. In fact, rising interest rates are a sign of economic strength.
When interest rates are low, people spend more money because they don’t pay as much in interest and have more disposable income. When people have more disposable income, they spend more money and stimulate the economy. This can lead to inflation if not properly monitored.
With higher interest rates, saving will be more profitable so it is wise to put your money in a savings account, especially online savings accounts that offer great rates. The high interest rates can help you while hurting borrowers. As interest rates rise, savings accounts could help you gain money rather than taking it away. According to the Federal Reserve’s Survey of Consumer Finances, the average amount of savings for a US family is $40,200.
Even as interest rates rise and the cost of borrowing becomes more, housing prices actually fall due to more people becoming less interested in buying.
As interest rates rise, it will be much easier to get a good return on low-risk investments such as CDs or bonds.
With rising interest, any fixed-rate loan will remain unaffected, which includes current fixed-rate mortgages, student loans and car loans.
Borrowing money will be come more expensive as interest rates rise, affecting rates that you can get for home loans, auto loans, personal loans and credit cards to name a few of the biggest financial borrowing industries. The Federal Reserve has shown that these rates have continued to rise since they increased their target rate in 2016. Of particular concern in a rising rate environment is your credit card debt, as well as adjustable-rate mortgages, as interest will increase on these loans.
Buying a Home
The interest on your new mortgage loan will be higher as interest rates increase. For instance, according to the Federal Reserve, the average 30-year fixed-rate mortgage increased by 0.75% between August 207 and 2018.
The stock market
Stock prices are typically hard to predict, but a typical rule of thumb is that as interest rates go up, stock prices should fall as more people will typically invest in bonds.
United States Economy
In a high interest rate economy, business will typically have to pay more interest on the debt they have and making it more expensive for them to invest in their business, usually resulting in slower economic growth. This can also affect consumers in the short term, making them less likely to spend in the economy. The biggest issue, according to the U.S. Treasury, may be the massive debt that has doubled in the last ten years. If interest rates rise back to average levels, the interest on the debt will be the highest item in the federal budget with super high interest payments.
How can we prevent inflation?
Inflation is when there is a general increase in prices and the value of the US dollar goes down. This usually happens as a result of too much money in the economy. When there is more money and not enough goods to meet the demand, prices will naturally go up. The same goes for the reverse: if there is too much supply, prices will fall. It’s just like a store selling in season items for full price and putting other items on sale.
In order to keep inflation at bay, The Federal Reserve needs to control the spending. If there is less money to go around, there is less demand. When there is less demand, prices drop. Following this model, The Federal Reserve will increase rates as an effort to control spending and prevent inflation, since goods will be more expensive without raising prices. When things are more expensive to purchase, people will generally be more cautious about spending. Eventually, prices will have to adjust by becoming cheaper, or by remaining the same.
How do mortgage rates affect the housing market?
The housing market is currently at an all-time high. People are making enough money, but there aren’t enough houses to accommodate everyone who wants to buy a home. With the interest rate slowly going up, we should eventually see a slow-down in home purchases, which will slowly bring down home prices over time. If you’re looking to purchase a home but are struggling to keep up with the rise in home prices, there are mortgage options like the FHA Loan which only requires a minimum of 3.5% as a down payment.
For much of the past decade, interest rates have been at historic lows. Interest rates set by most lenders tend to go up and down based on the federal funds target rate, or the rate at which banks can borrow from other banks, which is set by the Federal Reserve. This rate has ranged from around 1% to over 19% over the decades, but in the wake of the 2008 recession, it dropped to nearly zero and stayed there for five years. This made borrowing money cheap, encouraging consumers and businesses to spend – but it also discouraged saving, because the interest on bank accounts was so low.
Since 2016, however, the target rate has been slowly but steadily rising. By mid-2018 it was back up to nearly 2% – a rate that’s still low by historical standards, but getting close to normal territory – and the Federal Reserve has suggested there are more hikes to come.
As the target rate creeps upward, interest rates on other products, from credit cards to savings accounts, are also rising. This, in turn, will have an effect on lots of things you do as a consumer – from opening a bank account to buying a home. Here’s an overview of what you should expect as interest rates continue to rise, and what you can do to prepare for it.
How do you plan for higher interest rates?
Interest rates increasing will hurt many consumer’s bottom line, but some consumers can improve it by understanding how to be prepared and what to do in a rising rate environment, using the high rates to their advantage. If it is understood that interest rates are going to rise, consumers with credit card debt should look to pay off this as fast possible. Further, consumers should try and avoid new loans in this type of environment as they will be locked into a higher rate. With this, it is super important to try and lock in your interest rates now to make sure that you take advantage of the lower interest rate. This entails looking into refinancing your mortgage if you have an adjustable-rate-mortgage to make sure that you have a fixed-rate as interest rates rise.
Saving will also be key since savings rates typically increase and you can earn more on your money in these conservative investments. Bonds, in particular, will offer higher returns, but it is important to make sure you stick to short-term bonds, as with longer term bonds you can get stuck with earning a low rate for a longer period of time than you need to. Finally, if you are looking into buying a home, while mortgage interest rate are higher, the price of a home could be much lower and renting higher with a lot of people unable to afford to buy a home. With this, you should really look at the benefits of renting vs. buying a home.
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