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. See no closing cost refinance loan options.
#3 Interest Rates Are Higher
At this current time, 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 interest rates today. Learn more about the current tax rules for deducting interest on cash out refinance loans.
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. If your credit is less than perfect, see our home equity loan options for bad credit borrowers.
#4 Credit Score Requirements
You must have a a high enough credit score to qualify for a refinance 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. See refinance with bad credit mortgage options.
#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.
What Closing Costs Should You Expect with a Cash-out Refinance Closing Costs
Refinance closing costs typically range from 2% to 6% of your loan amount, contingent on your loan size. Similar fees for a cash-out refinance and a purchase mortgage include origination, title, appraisal, and credit report costs. Notably, origination fees and premiums for title and homeowners insurance are proportionate to your loan amount, meaning that higher borrowing amounts lead to increased closing costs.
Can Cash Out Refinancing Negatively Impact Your Credit?
Engaging in cash-out refinances may have two detrimental effects on your credit score. Firstly, it involves substituting old debt with a new loan. Additionally, assuming a larger loan balance has the potential to elevate your credit utilization ratio.
What is the timeframe for Cash-Out Refinance Approval?
Your existing lender may require a waiting period of six months between mortgages, but you have the option to refinance with a different lender without such constraints. Keep in mind that if you intend to take cash out, you’ll need to wait six months from your last closing before proceeding with the refinance.
Please consider these facts in mind if you want to pull out cash with a first mortgage refinance.