Unexpected expenses happen.
When they do, refinancing your mortgage might be something to consider.
A cash-out refinance loan can provide necessary funds to handle unplanned costs such as sudden medical emergencies or planned financing like education or home renovations.
Let’s go over the basics of cash-out refinancing, the requirements, and how to get in touch with a loan specialist to start your refinance.
What is cash-out refinancing?
A cash-out refinance lets homeowners tap into the equity they’ve built up and get a lump sum cash payment.
Cash-out refinancing mortgage replaces your existing mortgage with a new loan.
With cash-out refinancing, there are no limits or restrictions on how to use the money you receive.
How does cash-out refinancing work?
With cash-out refinancing, you get a new mortgage for more money than your existing loan mortgage.
Your new mortgage repays your initial loan and will have updated terms like lower monthly payments or better interest rates.
Because your refinance loan is for a larger amount than your original loan, you get the difference in cash.
What can I use the money from cash-out refinance for?
The money you get from a cash-out refinance can be used for anything you want. Some common uses include the following.
Home improvements, repairs, or renovations
Making upgrades or repairs to your home can be costly. Cash-out refinancing lets homeowners access the necessary funding to complete home renovations or remodeling projects.
Because home improvements can also increase your home’s value, many homeowners consider it a worthwhile investment.
Consolidating high-interest debt
Mortgages typically offer better interest rates than credit card debt, student loans, auto loans, or personal loans.
A cash-out refinance mortgage loan can allow homeowners to pay off high-interest debt sooner. Additionally, when you consolidate debt, you no longer have to make multiple payments on different dates to different creditors.
Big-ticket items like weddings or college tuition can be challenging to fund. However, with cash-out refinancing, homeowners may be able to pay some—or all—of the expense at better interest rates than personal or student loans or consumer credit cards.
Cash-out refinance requirements
While requirements can vary depending on which lender you’re working with, some general requirements are common to the general cash-out refinance process.
Credit history and credit score
A good credit score lets lenders know you make your payments on time. Lenders look at your credit score and credit history when you first apply for a new mortgage loan. The same thing happens when you apply for a cash-out refinance mortgage.
The minimum credit score you’ll need to qualify for a cash-out refinancing home loan can vary among mortgage lenders.
Debt-to-income ratio (DTI)
Your debt-to-income ratio (DTI) helps lenders determine whether you can realistically handle a cash-out refinance mortgage loan. To calculate your DTI, divide your monthly debt by your monthly income.
If your monthly income is $2,000 and your monthly debt is $900, your DTI is 45%. ($900 ÷ $2,000 = 0.45 or 45%)
The lower your DTI percentage, the better your chances of being approved for a cash-out refinance mortgage. Most lenders have a maximum DTI of around 40%.
Loan-to-value ratio (LTV)
Another percentage lenders look at when considering a borrower’s ability to repay a mortgage is the loan-to-value ratio (LTV).
To calculate your LTV, lenders divide your current mortgage balance (how much you owe) by your home’s current appraised value. The result is your LTV percentage.
If you have a mortgage balance of $100,000 and your home is appraised at 150,000, your LTV percentage is 66%. ($100,000 ÷ $150,000 = .66 or 66%)
Some lenders require an LTV ratio of less than 80% for cash-out refinance mortgages.
Cash-out refinancing and home equity
Your ability to qualify for a cash-out refinance all starts with the equity in your home.
Equity is your home’s appraised value minus the amount you still owe.
How much equity do you have in your home?
If your home is appraised at $150,000 and you still owe $100,000 you have $50,000 worth of equity in your home. ($150,000 – $100,000 = $50,000)
How do I increase the equity in my home?
Home equity increases when you make payments on the mortgage principal and if your home’s appraised value increases.
Lenders typically have minimum home equity requirements—the amount of equity that must remain in the home—that limit how much you can borrow with a cash-out refinance.
Many lenders typically require a minimum of 20% home equity for a cash-out refinance, which means you would be able to apply for cash-out refinancing for up to 80% of your home’s equity.
However, not all loan programs are the same. The VA loan refinance program allows eligible homeowners to refinance up to 100% of their home’s appraised value.
Let’s look at our example of a homeowner with $50,000 equity in their home but still owes $100,000 on their mortgage,
If they want to take $40,000 out of their home equity, they would apply for a new mortgage totaling $140,000.
Once the loan is closed, their existing mortgage of $100,000 would be repaid. In its place, they’d have a new mortgage for $140,000 and a cash payment of $40,000.
In this scenario, the equity in their home has now decreased to $10,000.
Cash-out refinancing pros
Some benefits homeowners can enjoy with a cash-out refinance include:
- Better interest rates
- Improved credit score
- Consolidate debt/ streamline monthly debt payments
- More cash in their monthly budget
- Mortgage interest tax deductions
Cons of cash-out refinancing
Some disadvantages of cash-out refinancing can include:
- Risk of foreclosure
- Higher monthly mortgage payments
Difference between cash-out refinance and standard refinance
If you want to refinance your original mortgage for a new loan with better terms or lower interest rates—but without tapping into the equity in your home—you can apply for a no-cash-out refinance.
No cash-out refinance is similar to a cash-out refinance, except you don’t receive a lump sum payment.
You’ll go through a similar process with the intention of simply lowering your monthly payment rather than cashing out any equity.
In the end, you’ll have one monthly payment that’s hopefully lowered to your desired range.
Get in touch with Assist Home Loans to guide you through your refinancing process.
Refinancing your home is a big decision.
Our trusted loan officers can walk you through the process and provide the insight and advice you need to make an informed cash-out refinancing decision.
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