What is a Cash Out Refinance?

A cash out refinance is a way of refinancing an existing mortgage in which the new mortgage is higher than the original plus loan settlement. This pretty much acts as an alternative to a home equity loan because the equity is taken from the home. As a result, the borrower receives the difference of the new mortgage and existing mortgage. Before you consider this form of refinancing, here are some things you should know.

Why should you opt for a cash out refinance? photodune-2641552-on-vacation-xsFOTOR

A cash out is a perfect way of using your equity for cash lump sum on a number of items for your home or personal affairs. For example, if you were planning a vacation somewhere, you could use the cash toward financing a great trip away from home. Also, it’s a great way to consolidate and pay off high credit card debts and even auto-loans. In an indirect way of paying off your credit cards, you could increase your credit score. A very smart way to use your cash out is to generally invest in your home and increase its value. Overtime this can decrease your loan to value rate as well as increase your equity. Develop a plan that makes sense for investing your money in other things as well. Or if you have to bail yourself out of an emergency, use your money wisely.

 

Drawbacks of a cash out refinance

If you plan to use your money for a second mortgage, you’ll have a bunch of fees to pay especially refinancing your first mortgage and cashing out. You essentially lose the equity you’ve built and you take on more debt because you have to replace the money you took out. This actually resets your mortgage. As a result, you will pay closing costs, interest on your cash out along with the mortgage amount. Also, you won’t be able to cash out until you’ve had the property for at least a year. This is especially the case for lenders who find investors quickly refinancing homes and cashing out without zero money down on the property. Lenders put a serious check on those who cash out through this manner. Even though some lenders will allow a cash out up to 75% loan-to-value without a 12 month seasoning, it’s generally uncommon for homeowners to raise 25% in a short period of time. Note that refinancing in general is risky and can lead to more debt with your new mortgage amount due to going underwater.

Saving money concept

What are some restrictions of a cash out refinance?

Seeing as there’s high risk involved with cash outs, lenders may have a much higher expectation for your credit score such as 680 or even 700. Remember, in all forms of borrowing, the lender wants to reduce as much risk as possible. Mortgage companies that insure cash out refinancing plans only have a loan to value (LTV) ratio of 85% while other forms of refinancing reach a higher amount. Also, keep in mind that higher payouts mean higher monthly payments. Due to your credit score and LTV, interest rates can go up.

 

Use FHA official website to your advantage especially for FHA cash out refinance rules

The federal government has their own set of rules when it comes to cash out refinance such as any co borrower being added to the note must be an occupant. It enforces a sense of primary residency. Additionally, borrowers aren’t eligible if they have any mortgage delinquencies within the most recent 12 month period. Any major debt consolidation requires considerable review due to the magnitude of the risk.

Are there alternatives to a cash out?photodune-6876226-reduce-your-debt-xsFOTOR

To cut costs, a homeowner may apply to home equity loan or line of credit, which exists outside of the mortgage. With both a home equity loan and line of credit, you use your home as collateral. You use your line of credit as needed much like a credit card. However, you can get a lump sum of money using your home equity loan. While interest rates are lower from getting cash out, closing costs are usually higher.

 

If you have a good reason to cash out your finances, it’s a good idea to do so at the right time. Weigh your situation and find out how this would do more harm than good. Equity is a very important thing when it comes to ownership. Consider your possibilities before turning it into cash.

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