Mortgage “Cash-Out” Refinance
Growing Mortgage Trend: The Cash-Out Refi
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The cash-out refinance is back.
Between and July and September 2016, cash-out refinances accounted for 42% of all conventional refis closed as mortgage rates maintained historic lows and home values climbed.
The quarterly results match the largest one-quarter market share for cash-out mortgages this decade.
Data comes from government-backed Freddie Mac, which defines a "cash-out refinance" as a refinance which results in a new loan size which exceeds the old one by five percent or more.
And, not only does Freddie Mac report homeowners doing cash-out loans more often, it shows homeowners taking more cash out at a time.
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On average, during the third quarter, 9% of the money borrowed via refinance was used for "cash out". This, too, is the highest this decade.
Considering a refinance and planning to cash-out? The market's in your favor.
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What Is A Mortgage Refinance?
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A mortgage refinance is the literal re-financing of a mortgage. As in, there's an existing mortgage in place for your home, and you opt to replace that mortgage with a newer one.
Refinance mortgage loans are similar to purchase mortgage loans, except that fewer people are involved, paperwork requirements are less, and costs can be reduced.
You already own your home, after all, so there's no need to convey real property; or to sign and review purchase contracts between multiple parties.
There's also less work required for the title search and settlement services; and, the taxes collected during the home purchase process don't apply when doing a refi.
Refinancing your home is a "paper-pushing" process -- your old loan is paid off, your new loan gets started.
Many refinances will close in 30 days or fewer.
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In general, a refinance loan belongs to one of three categorizations:
- Rate-And-Term Refinance
- Cash-In Refinance
- Cash-Out Refinance
A rate-and-term refinance is a refinance where the interest rate is changing; or the term of the loan (i.e. its length in years) is changing; or, both.
Usually, rate-and-term refinances are used to reduce your home's mortgage rate, but they're also used to convert home loans from 30-year mortgages to 15-year loans, for example.
Homeowners switching to a 15-year mortgage from a 30-year save approximately 60% on mortgage interest paid over the life of the loan.
Rate-and-term refinances have been especially popular since the start of last year with mortgage rates on steady decline.
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Today's rates are roughly 75 basis points (0.75%) below last year's levels and homeowners are beginning to learn that you don't need to reduce your rate POST to have a refinance make sense -- especially with the ability to do a zero-closing cost mortgage.
Cash-in mortgages work a little bit differently.
With a cash-in mortgage, homeowners bring cash to their closing in order to force the recasting of a loan; or, to get access to rates available only at a lower loan-to-value (LTV).
For example, mortgage rates for condominiums are higher when the LTV of the loan exceeds 75%. Therefore, a refinancing homeowner may opt to cash-in refinance the loan to bring its loan-to-value to seventy-five percent or lower to get access to today's low rates.
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The cash-out refinance is the opposite.
With a cash-out refinance, a homeowner increases its loan balance by five percent or more, and receives the cash difference at settlement in the form of a check.
There are no restrictions on how a cash-out mortgage can be used, but restrictions on how much cash you can "cash out" may be in place.
These restrictions can vary by lender so be sure to get multiple quotes if you're planning to do a cash-out.
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How Can I Use A Cash-Out Refinance?
U.S. homeowners use cash-out refinances for a myriad of reasons, and each of them is acceptable
However, because mortgages get amortized over multiple years, the dollars you borrow will accrue interest over multiple years, too. Furthermore, when your home is sold, you will net fewer dollars at the settlement.
This is because cash-out refinances convert home equity into cash. You'll have a larger sum to repay to your bank.
Before cashing out, then, consider why you want to cash out.
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1. Complete home improvement projects
A cash out refinance can also be used to fund a home improvement project.
Home improvement projects are often expensive. Adding a master bedroom suite to your home could cost $100,000 or more; remodeling a kitchen could run $60,000 or more; and, remodeling a bathroom may be $50,000 or more as well.
Even "small" projects can carry a price tag of $20,000 -- think of a roof replacement, for example.
For home improvement projects geared at improving your home's energy-efficiency, there are specialized home loans available from the FHA and VA -- the FHA 203k loan and the VA Energy Efficient mortgage, respectively.
For everything else, a cash out refinance can be a better way to finance.
Cash out refinances are typically limited to 80% LTV. For loans above 80%, consider a piggyback loan.
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2. Pay off credit card debt
Cash-out refinances can be an excellent way to retirement lingering credit card debt.
Typically, credit card balances accrue at interest rates of between 14-18%. Mortgage debt, by contrast, is available at rates between 3-5%. There's a lot of interest saved there. Payments can come way down, too.
A popular refinance strategy for retiring credit card debt involves paying all open credit cards down to $0, then using the monthly savings to reduce the new loan's active principal balance.
In this way, homeowners can save hundreds -- sometimes thousands! -- of dollars per month while reducing their overall debt load. A lender can clarify how this could work for you.
The process is known as Debt Consolidation. It only works if you work to keep credit card balances low in the future, however.
3. Fund a 529 plan / prepare for retirement
A cash out refinances can also be used to quick boost to your savings.
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As an asset class, real estate can build wealth quickly because gains are based on a larger "starting number". 5 percent gains on a $500,000 home creates $25,000 in wealth, whereas a 5 percent gain on $50,000 in stocks creates just $2,500.
However, investment products can bestow tax advantages, such as with certain retirement plans and with the 529 College Savings program.
Today, with mortgage rates low, it can be an opportune time to "borrow cheaply" against your home for the purposes of investing in your own retirement and/or long-term saving plans.
Note: This is a not a play for arbitrage. It's a way to invest large sums into tax-advantaged, interest-compounding accounts. Before embarking on this strategy, review your plans with a trusted financial planner.
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4. Buy an investment property
Cash from your primary residence can be applied toward the purchase of another property, such as an investment (rental) property.
This is a great way to expand your real estate portfolio.
In many cases, homeowners take a cash-out loan on their home and buy a rental in cash. When they want to invest again, they do a cash-out refinance on their investment property to buy another one. The result is a robust collection of rentals that are producing ongoing income.
4. Buy a second home
If you're not into being a landlord, but want another home, you can cash-out your primary residence to buy a second home (vacation property).
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With as little as 10% down, you can purchase a vacation spot for your family. No booking hassles, no sky-high hotel prices.
Today's home values are high, making it easier to raise enough down payment cash to buy a second home.
5. Tap the equity in your rental property or second home
Already own a rental or vacation property? You can get cash-out financing on those, too.
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Following are loan-to-value (LTV) limits for fixed-rate loans for these transactions:
- 1-unit second home cash-out: 75% LTV
- 1-unit investment property cash-out: 75% LTV
- 2-4 unit investment property cash-out: 70% LTV
If you plan to get an adjustable-rate mortgage, reduce the above LTV limits by ten percentage points.
Other Reasons To Cash-Out
And, there are other reasons to cash-out, too.
For some people, cashing out of a home is a means to diversify an investment portfolio and protect against a crash in real estate prices.
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Consider that our homes are typically our largest asset. And, as home values increase, so does our total home equity. This means that every month home values rise, the amount of money we have invested in real estate rise, too.
However, as many homeowners discovered in the middle of last decade, home equity is money on paper until you convert it to cash.
You can't use it, you can't spend it, and when home values crash, your equity can disappear quickly -- just ask homeowners in California, Florida, and Arizona circa-2006.
A cash-out refinance can help you to diversity your holdings; and, to protect against a housing market downturn.
Remember: It's easy to cash out when home values are rising. It's a challenge when values are not.
What Are Today's Cash-Out Mortgage Rates?
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When mortgage rates drop, U.S. homeowners get chances to refinance for lifelong savings. However, when mortgage rates drop at the same time home values rise, homeowners can "cash-out" for a variety of excellent purposes.
Take a look at today's real mortgage rates now. Your social security number is not required to get started, and all quotes come with instant access to your live credit scores.
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