What is cash-out refinancing?

In the area of ​​real estate, Cash out refinance is called the refinancing of a mortgage. It is the process of replacing an existing mortgage with a new one that generally offers more favorable terms for the borrower..

By refinancing your mortgage, you can lower your monthly payments, negotiate a lower interest rate, renegotiate the number of years (term) on the loan, remove other borrowers from the loan obligation, or access cash through the home equity that has been amortized.

Cash out refinancing is a mortgage refinancing option in which the new loan is greater than the existing loan, in order to convert the home equity into cash.

Key information:

  • In a “cash out refinance” or cash refinancing, the new mortgage is greater than the balance of the previous mortgage and the difference is delivered in cash.
  • As usual, you’ll pay a higher interest rate or more points on a cash-out refinance mortgage, compared to a “term-rate” refinance, in which the amount of your mortgage stays the same.
  • Depending on the loan-to-value ratio of your property, the lender will set a maximum on how much money you can take out when you refinance.

Cash-out refinancing vs. term refinancing

term refinancing

The most basic mortgage loan refinancing is the “rate-term”. With this type, you try to get a lower interest rate and/or adjust the term of the loan.

For example, if your property was purchased years ago when rates were higher, you may find it advantageous to refinance to take advantage of today’s lower interest rates.

Also, the variables may have changed in your life allowing you to handle a 15-year mortgage (saving massively on interest payments), even if it means giving up the lower monthly payments on your 30-year mortgage.

Cash-out refinancing

The “cash out refinance” has a different objective. Allows you to convert home equity into cash by creating a new mortgage for an amount greater than what you currently owe. You receive the difference between the two loans in cash tax-free (the money is not counted as income by the government).

This is possible because you only owe the lender what is left of the original mortgage amount. The additional loan amount of the refinanced cash-out mortgage is paid to you in cash at closing, which is typically 45-60 days from the time of application.

Compared to term-rate refinancing, cash out refinance loans typically have higher interest rates or other costs, such as points.. Lenders worry that if you’ve already raised considerable equity, you’re more likely to walk away from the new loan, though a high credit score and low loan-to-value (LTV) ratio may allay those concerns and help you land a favorable deal.

The federal government offers cash refinancing through the Department of Veterans Affairs (VA).

Example of a refinancing Cash out refinance

Let’s say you took out a $200,000 mortgage to buy a property and after many years, you still owe $100,000. This means you’ve written off at least $100,000 in home equity (assuming the property’s value hasn’t dropped below $200,000). To convert part of that capital into cash, you can opt for a cash out refinance..

If you want to convert $50,000 of your principal, you can refinance by applying for a new loan for a total of $150,000. The new mortgage would consist of the remaining $100,000 balance of the original loan plus the desired $50,000 that could be taken out in cash. In other words, you can take on a new $150,000 mortgage, pay back the $100,000 you owe on the first mortgage, and have $50,000 in cash left over.

By calculating the property’s current loan-to-value (LTV), a lender can set a maximum loan amount for a cash-out refinance. The lender looks at the current market value of the property compared to the outstanding balance the borrower owes on the current loan.

Continuing with the example, let’s say the current market value of your property is $250,000. And since the lender has set a maximum LTV of 80%, the maximum cash refinance amount would be $100,000. The 80% LTV would set the maximum new loan amount to be $200,000, or $250,000 x 0.80. After the initial mortgage is paid off ($100,000), there would be $100,000 in cash available to you.

Refinancing in cash vs. home equity loan

What’s the difference between a cash-out refinance and taking out a home loan? Well, with a cash refinance, you pay off your current mortgage and get into a new one. With a home loan, you are taking out a second mortgage in addition to the original, which means you now have two liens on your property. This translates to having two separate creditors, each with a possible claim on your home.

Closing costs for a home equity loan are generally less than for a cash refinance. Therefore, if you need a considerable sum for a specific purpose, it may be the best alternative. However, if you can get a lower interest rate with a cash-out refinance and plan to stay in your home long-term, refinancing probably makes more sense.. In both cases, you must make sure of your ability to pay, because otherwise you could end up losing your house.