A Homeowner’s Guide To A Cash-Out Refinance
Buying your home is probably one of the biggest investments you’ll ever make, and you likely want to do everything you can to make sure your home is as comfortable and up-to-date as possible. But it can be tough to build up the necessary savings to complete home renovations and repairs.
A cash-out refinance may be your answer. It can help you accomplish your home improvement goals so you don’t have to rely on credit cards, a personal loan or a second mortgage. A cash-out refinance helps you use the money you’ve already paid into your mortgage to do things like cover repair bills, consolidate multiple debts or even pay off your outstanding student loans.
What’s A Cash-Out Refinance?
As your mortgage matures, you gain equity in your home. Equity refers to the amount of a home’s value that you actually own. You can gain equity in two ways:
- Your home increases in value.
- You pay off your mortgage principal through your monthly mortgage payments. Every time you make a monthly payment on your loan, you gain a bit more equity in your home.
A cash-out refinance takes advantage of the equity you’ve built over time and gives you cash in exchange for taking on a larger mortgage. In other words, with a cash-out refinance, you borrow more than you owe on your mortgage and pocket the difference.
Unlike when you take out a second mortgage, a cash-out refinance doesn’t add another monthly payment to your list of bills – you pay off your old mortgage and replace it with your new mortgage.
For example, let’s say that you bought a home for $200,000 and you’ve paid off $50,000. This means that you still owe $150,000 on your home. Let’s also say that you want to make $20,000 worth of renovations.
With a cash-out refinance, you take a portion of your equity, then add what you’ve taken out onto your new mortgage principal. This means your new mortgage would be worth $170,000 – the original $150,000 you owed on the home plus the $20,000 you need for renovations. Your lender gives you the $20,000 in cash a few days after closing.
When you refinance, you can do anything you want with the money you take from your equity. You can make repairs on your property, catch up on your student loan payments or cover an unexpected medical or auto bill. Cash-out refinances also usually give you access to lower interest rates than credit cards.
Benefits Of A Cash-Out Refinance
A cash-out refinance can be better than taking out a personal loan or second mortgage for a number of reasons.
Home Improvements And Renovations
From questionable design choices to a broken HVAC system, upgrades are often necessary. A cash-out refinance allows you to use the equity you’ve already earned to fund the changes you need.
A cash-out refinance can give you the cash you need to pay down your outstanding debts and transfer what you owe to one convenient, lower interest payment.
Lower Interest Rates
If you put an unexpected bill on a variable credit card, you might pay a high amount of interest – the prime rate that’s tied to the federal funds rate set by the Federal Reserve, plus a certain number of percentage points on top of that. Mortgage rates are generally lower than credit card interest rates and currently hover around 4-5% for 30-year fixed rate loans. If you have enough equity in your home to cover your bill, you may save thousands in interest over time.
More Money To Invest
When you take into account the power of compounding interest, it can be a smart move to free up money and save towards retirement early rather than keep your funds tied to your home. Cash-out refinances give you access to funds that you can use to boost your retirement savings or build up a college fund.
Things To Consider About A Cash-Out Refinance
You might need to consider a few things before you commit to a cash-out refinance, including:
Leave Equity In Your Home
Let’s say you’ve paid a total of $20,000 on your mortgage principal. You might assume that this means you can take up to $20,000 out with a cash-out refinance. However, depending on your loan, this isn’t always possible. Conventional loans require you to leave between 15-20% equity in your home after a refinance, and FHA loans require at least 15%. The only exception to this rule is with a VA loan refinance, which doesn’t require you to leave any equity after you refinance.
Just like when you buy a home, you’ll pay closing costs when you refinance. Some common closing costs include credit report fees, appraisal fees and attorney fees, depending on your state. If you only need to take out a very small loan, you should take a look at whether the closing costs would negate anything you save with a lower interest rate. In cases like this, resources like Rocket Loans® can help you look at your options for personal loans.
You Don’t Get Cash Immediately
Similar to when you buy a home, you must submit to underwriting and appraisal processes before your lender approves your refinance. Even after you close, the Truth in Lending Act requires your lender to offer you three days to cancel the loan if you have a change of heart, and you won’t get your cash until three to five days after closing. If you need cash immediately, a cash-out refinance may not be the right solution.
Your Loan Terms May Change
When you get a cash-out refinance, you pay off your original mortgage and replace it with a new loan. This means that your new loan may take longer to pay off, your monthly payments may be different or your interest rate may change. Be sure to look at the Closing Disclosure from your lender and analyze your new loan terms.
You’ll Need An Appraisal
Cash-out refinances are contingent upon an appraisal by an independent third party. Appraisals can take time, so factor this into your refinancing timeline.
How Does A Cash-Out Refinance Work?
The cash-out refinance process is similar to the process you undergo when you buy a home. After you know you meet the requirements, you choose a lender, submit to underwriting, get an approval and wait for your check.
Your lender sets their own requirements when it comes to deciding who qualifies for a refinance. Some of the most common cash-out refinancing requirements include:
A Credit Score Of At Least 620
To refinance, you'll usually need a credit score of at least 580. However, if you're looking to take cash out, your credit score will need to be 620 or higher.
A Debt-To-Income (DTI) Ratio Of Less Than 50%
Your DTI ratio is the amount of your monthly debts and payments divided by your total monthly income. For example, if you pay $1,500 in bills every month, including your mortgage, and you have a total monthly household income of $4,000, your DTI ratio is $1,500 divided by $4,000, or about 37.5%. Most lenders require that your current DTI ratio be less than 50% to refinance your loan.
Equity In Your Home
You’ll need to already have a sizeable amount of equity built in your home if you want to secure a cash-out refinance. Remember that your lender won’t let you cash out 100% of the equity you have unless you qualify for a VA refinance, so take a careful look at your current equity before you commit to a cash-out refinance.
Adding It All Up
Once you know that you meet the requirements for a cash-out refinance, determine how much money you need. If you’re planning to cash out for repairs or renovations, it’s a good idea to get a few estimates from contractors in your area so you know how much you need.If you want to refinance to consolidate debt, sit down with all of your credit card and bank statements and determine exactly how much cash you need to cover your debts.
After you apply for a cash-out refinance, you receive a decision on whether your lender approves the refinance within a few days or weeks. Your lender might ask you for financial documents like bank statements, W-2s or pay stubs to prove your DTI ratio. After you get an approval, your lender walks you through the next steps towards closing.
Whether you want to pay down debt or renovate your kitchen, a cash-out refinance can be a powerful tool and can give you the money you need to move towards your goals. If you’re not sure if a refinance is right for you, speak with a financial advisor, use an online refinance calculator or speak to a Quicken Loans Home Loan Expert for help. If you’re ready to get started, Rocket Mortgage® by Quicken Loans® can help you explore your options!
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