Cash Out Refinance

June 4, 2016

Refinancing presents a great opportunity for homeowners with equity to take some cash out.  This is known as a cash out refinance.

A “cash out refinance” simply means taking a new loan on your house for a higher amount than your current principal balance, and receiving cash for another purpose from the loan proceeds.  If you currently owe $150,000, and your new loan is for $200,000, you would be taking $50,000 cash out.  Regardless of your reason for taking cash out, qualifying guidelines are the same.  It does not matter if you use the funds for home improvements or a trip around the world.

There are four common reasons to take a cash out refinance:

  1.  Consolidate debt and improve your overall cash flow.  The interest rate on credit card debt and installment loans is typically higher than the rate on a home loan.  Consolidating all debt into one monthly payment simplifies your life by making it easier to manage your monthly bills, and in most cases significantly improves your monthly cash flow.  A refinance will be considered a “cash out refinanace” even if you’re paying off a 2nd lien on your home (a HELOC or home equity loan), if that second loan was not originally used to purchase the property.

Let’s take a look at how a debt consolidation cash out refinance can help.

Current Financial Snapshot:

Mortgage Payment  – $150,000 @ 6%  = $899.33 per month for 30 years

Installment Loan – $12,500 @ 9% = $259.48 per month for 5 years

Credit Card #1 – $16,000 @ 9.24% = $290.00 per month minimum (no end in sight*)

Credit Card #2 – $6,500 @ 14.99% = $97.50 per month minimum (no end in sight*)

Credit Card #3 – $3,800 @ 22.99% = $57 per month minimum (no end in sight*)

Closing Costs – $2,500

Cash at Closing – $8,700   This money will be either wired to your bank account or issued in a check.  Use it as emergency savings, to make minor home improvements, or however you need.  It’s your money to do with as you wish.

*By “no end in sight” we mean that often on revolving accounts, making only the minimum payments will take upwards of 20 years to pay off the account in full, assuming you make no other charges.  However, your monthly payment will decrease as your balance is paid down, greatly increasing the time it takes to pay off your balance.

TOTAL CURRENT MONTHLY DEBT EXPENSES:  $1,660.31

New Home Loan

Loan Amount of $200,000 @ fixed rate of 4.75% for 30 years = $1,043.29 per month

TOTAL PROPOSED MONTHLY DEBT EXPENSES:  $1,043.29

That amounts to an increase of $143.96 for your mortgage payment, but an overall decrease of your monthly expenses by $617.02, or $7,404.24 per year!  On a fixed salary, that is a significant amount of extra money freed up for daily expenses, emergencies, or savings.  With enough extra cash each month, you’re less likely to NEED to use credit or debt to cover your monthly expenses, and therefore less likely to end up back in debt.

Using this exact same scenario above, if you were to pay that additional $600 that you’re saving toward your monthly mortgage payment, you will pay off your entire $200,000 mortgage in 14 years instead of 30.  So if you’re hesitant to refinance a loan after you’ve already paid for 5 or 8 years, you can actually choose to keep your monthly outgoing expenses the same (which you will have to do anyway if you don’t refinance), and pay your loan off years SOONER with a refinance.  If you have a bad month, or need extra money, you have the option to skip making the larger payment that month.  Just remember, the more additional principal you pay early in your loan, the more impact it has on paying off your mortgage early.

Depending on your current debt to income ratio, the accounts being paid off may need to be closed as a condition of approving the loan.  This will be necessary if your current income does not support your current monthly outgoing debt expenses according to loan qualifying guidelines (i.e. if you’re currently overextended and stretching to make your payments).  While you can apply for a new account after closing, the lender wants to decrease the likelihood that borrowers will fall into the same pattern of incurring debt.

It may seem confusing to close an account before it is paid in full, but credit card accounts may be closed with a balance.  At closing, the escrow company will give you a check made out to each creditor to pay off the account(s).  You do not get a suitcase full of cash, or a lump sum to distribute to your creditors; the checks will be prepared for you and paid out from the loan funds.

  1.  Home Improvements or Home Addition   Adding to your current home or significantly improving it through remodeling is a smart way to re-invest your equity, and if you love your home and neighborhood it’s a great alternative to moving.  After living in the home for many years, you probably have a good idea of what improvements would best suit your needs.  It’s often easier to create exactly what you want in your existing home, than to find it in a new home within your budget.

Instead of taking on credit card debt or using savings, you can borrow your equity at a low interest rate to complete your home improvements, and you’ll still have one low payment.

Well-constructed permitted additions and remodels increase the value of your home.  New kitchens, baths, and additional square footage are the biggest ways to create equity.  Deferred maintenance can also be repaired with cash out proceeds.

Just remember, you should never ever start your remodeling or construction until your loan has been approved.  An appraisal will be ordered for all cash out refinances, and if the appraiser sees any construction he or she will have to note it on the appraisal.  This is a huge red flag for an underwriter, and will most likely result in the denial of your loan.  Lenders cannot extend loans on properties under construction – these are Fannie Mae guidelines.  The last thing you need is to have a half-completed project with no money to finish it!  Wait until you have cash in hand from your loan to swing your hammer.  It is perfectly ok to use the cash out for a construction project, it just cannot be in progress during the loan process.

  1.  Purchasing Investment Property or a Second Home   The third reason people typically take out equity is to purchase investment property or a second home, since it’s one of the fastest ways to access a large sum of money without selling your home.  The funds from your cash out refinance can either cover the down payment for the new property or the entire purchase, depending on how much equity you have, and how much borrowing power your income can support.  If you qualify to borrow enough to pay cash for your investment, you’ll have the most freedom in choosing a new property.  If you need to take out a loan for your next purchase, you will have to qualify for both loans.  If the new property is a rental, we can qualify you using a portion of the rental income on the new property.

Equity Builders Challenge:  Using the proceeds from a cash out refinance and find an investment property that produces enough rental income to cover the expenses on both properties!

  1.  Buy a Car, Pay for School, Take an Extended Vacation, Start a Business, Fulfill Your Dreams    This last category covers anything else you choose to do with your money.  The sky is the limit (well, and your loan-to-value and debt-to-income ratios). 

Next, let’s look at how much equity you can borrow through a cash out refinance.  ==>