The Basis Point and CNN just teamed up on cash out refinance mortgage education. Here are 4 critical cash out refinance tips to make smart decisions, plus a link to the full CNN post. Please ask me questions in the comments below, or use the link at bottom of post to reach out directly.
1. WHAT ARE THE PROS & CONS OF A CASH OUT REFINANCE?
Irresponsibly or prematurely eroding your home equity by taking cash out is the primary con of a cash out refinance. But a great loan advisor can help you determine whether cash out is the best financial plan for your objectives at any given time.
There are two main types of cash-out refinances:
(1) refinancing your first mortgage into a new higher balance that pays off your existing loan and puts cash in your pocket, and
(2) adding a fixed-rate second mortgage that gives you a lump sum of cash at closing or a Home Equity Line of Credit (HELOC) second mortgage that lets you draw cash off it and pay it down much like a credit card.
The pros of a cash-out first mortgage is the rate will be drastically lower than a fixed rate or HELOC second mortgage.
Let’s say you got a $200,000 30-year fixed loan at 4% when you bought your home in Spring 2019. As long as you have enough equity in the home, today you could take out up to $25,000 with a cash out refinance at around 3.25% and keep your payment the same.
2. WHICH TERMS ARE IMPORTANT TO EVALUATE WHEN CONSIDERING A CASH OUT REFINANCE OFFER FROM A LENDER?
The IRS only allows you to deduct mortgage interest on home purchase financing, so increasing your loan amount for a cash-out refinance will not increase your tax benefit.
Also keeping cash out loan payments in line with your budget is most important.
Rates for cash out refinances are .125% to .25% higher than rates for non-cash-out or home purchase loans.
But rates have dropped to historic lows in recent months, so cash-out refinances are worth exploring for those who might need cash and have enough equity.
Refinance closing costs can range from $2000 to $5000 depending on where you live and the price of your home.
Note that closing costs will be deducted from your cash in hand at closing on a cash-out refinance.
So if your desired cash-out was $25,000 but closing costs were $2,500, then you’ll end up with $22,500 at closing. Your lender can brief you on these details.
3. HOW MUCH EQUITY DO YOU GENERALLY NEED IN YOUR HOME TO GET A CASH OUT REFINANCE?
Most lenders require at least 20% equity right now to approve a cash-out loan. This means the new loan balance that includes the cash out must not exceed 80% of your home’s value.
So if you have a loan for $200,000 now and want $25,000 cash out, then your home must be worth $281,250 or higher.
A loan advisor can help you assess whether you’re in the range.
Or if you want to do the math yourself, add your desired cash out to your existing loan balance, then divide that number by 80% (or .80 on your calculator) to get the value you must have.
Then you can talk to a lender (or a realtor) to see if they think your home might appraise for that amount.
4. WHO SHOULD (AND SHOULDN’T) CONSIDER DOING A CASH OUT REFINANCE RIGHT NOW?
With rates as low as they are, a cash-out refinance is a cheap way to get cash. But all lenders require you to have more equity right now (at least 20%) because they don’t want people using homes like ATM machines like in the last crisis when home prices were dropping.
We’re still early in the COVID economy and while home prices have held up, lenders have tightened equity requirements to make sure homeowners don’t over leverage themselves.
Here is the latest housing and mortgage outlook to see where things might go in 2021 and 2022.
– Please reach out with cash out refinance questions or comment below.