Cash-Out Refinancing Basics
When you enter into cash out mortgage refinance you are making use of the equity that you enjoy in your home. The equity in your home is the part that you own outright. If you have a home that is worth $120,000 dollars, and you owe $90,000 dollars on your mortgage, then the amount of equity that belongs to you is $30,000 dollars. For most all mortgage refinances, you will not be able to borrow all of the available equity in the home.
When you refinance, any kind of refinancing, you are basically in some way trading your previous mortgage for a new mortgage. The new mortgage will likely have different options, a different mortgage rate, different term or length, and a different loan amount than your current mortgage loan. Using cash out mortgage refinancing, you enter into a mortgage for more than the mortgage you currently own, and the mortgage lender or bank gives you a lump sum check for the difference. When you refinance and you use the money for anything other than paying the existing mortgage and costs, you are doing a cash out refinance. Even if the money is used to consolidate your debt it is still considered a cash out refinance transaction.
Utilizing cash out refinancing allows an existing homeowner to access some of that equity to use for beneficial purposes. Borrowing against the equity in your home is almost always cheaper than other types of financing and the mortgage interest in most cases is tax deductible. In a favorable mortgage rate market, the cash out refinance may actually lower your monthly mortgage payment. If mortgage rates now are lower than when you first took out your mortgage, the payment may go down; in addition, since you are most likely extending the length of time for repayment, this may bring about a lower payment as well. Refinancing with new loan terms and possibly a lower mortgage rate can add value to an individual’s budget and personal balance sheet. Of course, even with a lower mortgage rate or monthly payment the full costs and benefits of cash out refinance should be reviewed. The process of comparing mortgage costs, mortgage rates, the loan amount and the costs and benefits of the mortgage refinance is easy to quantify with the use of a mortgage calculator.
After your previous mortgage is paid off with the cash out refinance home loan, the balance can be used for anything you choose to use it for. Debt payments, tuition, investing, home improvement, anything that you need a large sum of money for. If your interest rate on your cash out refinancing is lower than the original mortgage you had, the monthly rise in payments may be partly offset. If the interest rate is higher make sure you understand the implications on your financial position of extracting the cash out. Cash out refinance for conspicuous consumption can lead to budget problems down the road when refinancing no longer becomes an option.
Evaluating the costs and benefits of a refinance can include more than just how much money you save per month. Remember, if you pay off a four year auto loan with a 30 year mortgage, there better be a payment savings. In these cases you must factor in the total cost of interest and whether you will repay the mortgage faster with the additional cash flow. Evaluating inflation and the direction of interest rates should also be measured. Granted, this is almost impossible. But it hard to ignore the value of borrowing money at 5.75% fixed for 30 years in 2008 and discovering that inflation will be running over 5% in the ensuing years. Very little is paid to the terms of home equity lines of credit. These loans are almost always adjustable mortgage rates. The reason is that no financial institution provides a line of credit good for 15 or 20 years at a fixed rate giving the borrower to access the funds when market rates rise and the value of that line of credit at a low fixed rate skyrockets. Interest rates move based on various market forces. The most significant impact on rates is inflation.
There are clearly many factors to consider should you want a cash out refinance. The following considerations are the ones to address as you start to evaluate your individual needs.
Compare the mortgage rate and closing costs for the new home loan.
Compare those terms to your existing mortgage loan and its remaining term to avoid refinancing the existing balance at a higher overall cost.
The amount of cash you need including the amount to pay off the existing mortgage.
The purpose for the cash (This one has led many a borrower astray).
The amount of time you expect to be in the home or have this mortgage for.
Consider your tax bracket, other opportunities, and the overall direction of interest rates as well as your financial balance sheet.
In order to secure the loan request, cash out refinances are approved or rejected just like any other mortgage loan. Banks and mortgage lenders will sometimes allow you to finance up to one hundred percent of your homes value, provided that your credit is excellent. More often, the loan amount will have to be 95% or lower than properties appraised value. If income or credit situations tighten the restrictions you may be reduced even further on the amount of equity you can draw out. Depending on the amount of money that you owe on your first mortgage, the lender will often require private mortgage insurance in high loan to value requests. And as the amount financed becomes a higher percentage of your home’s value, the mortgage rate you are offered will increase as well.
Consider your needs, your existing financial health and what the future may hold. Research all loan types to see which best fits your needs. Be a proactive, be an educated mortgage shopper by reviewing all terms, the mortgage rates available and close on the new mortgage refinance that best fits your needs.