If you need a lot of cash to pay for a major expense – such as college tuition or a home renovation project – and you don’t have the cash for it, a cash out refinance of your first mortgage could be the solution.
A cash out refinance of your first mortgage allows you to borrow equity that you have accumulated in your home, usually at a lower rate than other loans, and get the cash for almost any purpose.
For many home owners, this can be an inexpensive way to borrow a lot of money for big ticket expenses. But there are many factors to consider when you commit to cash out refinancing, and in some situations, the cost of doing the cash-out mortgage refinance may be higher than other options.
How to Get Money through a Refinance Mortgage While Lowering Your Interest Rate
This article describes some of the secrets, tricks and pitfalls of doing a cash out refinance.
#1 You Are Taking Out a Larger Mortgage
If you want to get a new first mortgage and take out cash, remember that you are taking out a bigger mortgage. This can be perfectly fine, but remember you are going to be paying on the loan longer and paying years more interest, even if you scored a lower rate.
In a typical cash out refinance, if you have a mortgage of $150,000 on a home that is worth $250,000, you might refinance into a loan of $180,000. This replaces your old mortgage and gives you $30,000 in cash.
This can be a good way to pay for certain expenses, such as a home renovation. If you use the money wisely, you could add value to the home, which can make up for the fact that you are paying on a larger mortgage. When you sell, you could end up with more money in your pocket from the renovation.
#2 There Are Costs Involved
If you get a cash out refinance with a lower rate, you are getting cash and a better interest rate. But don’t forget there are closing costs, property taxes and homeowner’s insurance to pay. You will not always get the full difference between the new loan amount and your old loan amount. You could ask for a no cost refinance, but that means you are paying a higher rate, or the closing costs are added to your new loan. You will pay those expenses one way or another.
#3 Interest Rates Are Higher
In 2018 and going into 2019, we are in a rising interest rate environment. Rates for 30-year fixed rate mortgages have flirted with 5%. For some homeowners, you may not be able to get a lower rate than you have now. So, it may not be a good move to get a cash out refinance. One option would be to do the cash out refinance into a 5- or 7-year ARM, which might have a rate .5% or so lower than a 30-year loan.
Another option is to keep your first mortgage in place and get a second mortgage – either a home equity loan or a home equity line of credit (HELOC). These loans still allow you to tap your equity, but you are leaving your first mortgage in place. Rates on second mortgages are higher than firsts, but you still might get a 6% or so rate, which is still cheap money. Shop and compare pragmatically to uncover the best HELOC rates today.
Carefully look at your current first mortgage interest rate and what the rates are right now. If you can’t drop your rate at all, consider other options mentioned above and consider rates from competitive 2nd-mortgage lenders. Before making a commitment, learn how a HELOC works.
#4 Credit Score Requirements
You must have a credit score that allows you to apply for a new mortgage. Typically, you need a 620-credit score to qualify for a cash out refinance. If you do not have that high of a score, you will have difficulty qualifying. Focus on paying your debts and bills on time and pay off some debt if you can to raise your score.
#5 Loan to Value Ratio
The maximum allowable loan to value ratio today is generally 80%. This means the total outstanding home loan balance after a refinance is done cannot exceed 80% of the value of the home. So, if your home is worth $250,000, your new loan, combined with all other house debt, cannot be more than $200,000. If your debt is already more than $200k, you cannot get any more cash.
#6 Debt to Income Ratio
Your debt to income ratio is all of your monthly debt payments added up. This includes student loans, credit card loans, and auto loans, plus your mortgage payments, divided by your gross income each month. Generally, it has be less than 50% for you to qualify for cash out.
Keep these facts in mind if you want to pull out cash with a first mortgage refinance.
Top 4 Reasons Not to Refinance Your Mortgage for Cash Out
Millions of home owners are seeing the equity in their properties growing in 2018. That fact is causing some of them to refinance their mortgage for cash out. Refinancing your mortgage can sometimes get you a lower interest rate and also provide you with some much-needed cash for things you want, such as home improvements, education needs or consolidate debt. Below is more about cash out refinancing, how it works, as well as disadvantages and other considerations.
A cash out refinance occurs when you replace your current first mortgage by refinancing it with a bigger loan. By borrowing more than you owe right now, the lender will give you the cash from your equity to use as you wish. The cash usually will come to you in the form of a check or a wire transfer.
When you get your mortgage refinanced, it usually involves getting a lower interest rate. You might have a mortgage from years ago when rates were in the 6% range. As of late 2018, interest rates for first mortgages are higher than two years ago but are still under 5%. Some home owners may be able to refinance and save themselves on interest charges, plus take cash out.
How You Can Use the Money
You can use your equity in any way you like. Most financial experts recommend only using your equity for things that will enhance your finances. Common uses are:
- Home improvements: It can make sense to use your equity for home improvement projects. Some wise improvements can boost the value of your home and increase your equity. This will make it easier to recoup on your monetary investment when you sell. It is recommended to use the funds for projects that are very likely to increase your home’s value, such as kitchen and bathroom enhancements.
- Education: Earning a valuable degree can help you to get better paid work. If you think getting that new degree will help you financially, this may be a good use of your equity.
- Business ventures: Some people use equity to invest in real estate or a new business. This can be a good move, but it also is fraught with risk. You have to look at how you will pay back the loan and how your family could be affected if the business does not pan out. But a home loan is usually less expensive than a personal loan or credit cards. Also, banks frequently require you to use your home as guarantee for a business loan anyway.
- Consolidating debt: Paying off your high interest credit cards can be a smart move, but if you do so, there is more risk. Credit cards have high interest but are unsecured debt; the lender cannot take your home if you do not repay. It will only result in damaged credit and possible collection efforts. If you do not pay your home loan after you refinance, you can lose your home. FHA still allows qualified borrowers to get a FHA cash-out refinance with only 15% equity.
Those are the major reasons that people refinance their mortgages for cash out. Disadvantages of doing this include:
- Interest: When you refinance, you are starting your home loan over. You will increase the long-term interest costs; borrowing more money adds to this effect. If you want to avoid restarting your first mortgage, consider taking out a second mortgage instead.
- Foreclosure risk: If you cannot pay the loan, you will probably lose your home. Unsecured loans carry higher interest but are less risky.
- Closing costs: Every mortgage loan has up front closing costs that usually are thousands of dollars. You are always going to pay those costs one way or another: by rolling them into the balance, writing a check or taking a slightly higher rate.
- Financial discipline problems: Many people are tempted by the large amounts of money they can pull out of their homes, buying things that they do not really need and do not provide a financial return. If you take money out of your home to go on a vacation or buy a car, these are questionable uses of your hard-earned equity.
Getting a mortgage refinance with cash out can be a good move, but you need to make sure you have a really good use for the money. Also, rates are higher than a year or two ago, so refinancing your first mortgage may result in a higher rate. In that case, consider a home equity loan or home equity line of credit.