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Is cash-in refinancing a good idea? | Mortgages and advice

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If you’ve been paying your mortgage for several years or if your home has appreciated in value, a mortgage refinance with drawdown allows you to access some of the value stored in your home. With a cash-out refinance, you’ll get a new mortgage for more than you currently owe, allowing you to keep the difference in cash.

A cash-out refinance can be a good idea if you have a good reason to tap into the value of your home, such as paying for college or home renovations. A cash-out refinance works best when you’re also able to get a lower interest rate on your new mortgage, compared to your current one. This can be difficult to do in a rising rate environment like today. So when does it make sense to consider cash refinancing?

What is a cash refinance?

A cash-out refinance is when you take out a new mortgage to pay off your existing mortgage and the new mortgage is more than you owe on your existing mortgage. The difference is paid to you in cash.

Cash refinances allow homeowners to tap into the equity in their home to pay for expenses such as medical bills, home renovations, debt consolidation, and other major purchases.

In 2021, 42% of all refinances were cash outs, according to Freddie Mac, probably due to low interest rates at the time, which made refinancing very important. Average rates, however, increased throughout 2022, exceeding 6% for the first time since 2008 on September 15, 2022.

Although rates may be higher, homeowners continue to build equity in their homes. In the second quarter of 2022, mortgaged homes saw their net worth increase by 27.8% compared to the previous year, according to CoreLogic. That’s an average increase of $60,200 per borrower in one year. With more equity to work with, cash refinancing might still be attractive to some people.

Regardless of the economic climate, it’s important to understand the pros and cons of cash refinances and calculate your personal numbers before moving forward.

How a cash-in refinance works

A cash refinance works the same way as a regular refinance, except the amount of equity in your home plays a bigger role. Lenders typically approve cash refinance for up to 80% of your home’s appraised value. This is called the loan-to-value ratio. (A regular refinance can usually have a higher LTV.)

Sean Grzebin, head of consumer origination for Chase Home Lending, shares this example: Say your home is valued at $200,000 and you owe $100,000 on your mortgage. This means you have $100,000 in home equity. With a maximum LTV of 80%, your new loan can be up to $160,000. Paying off your existing mortgage would leave you with around $60,000 in cash (minus fees or closing costs if you roll them into the loan).

Withdrawal rollover requirements

Getting approved for a cash-out refinance isn’t all that different from a regular refinance, but some lenders may hold you to higher standards, says Grzebin. “Cash-in refinances typically require a higher credit score and lower loan-to-value ratio to ensure the customer’s ability to repay the loan with higher monthly mortgage payments,” he says.

In addition to meeting the lender’s debt-to-equity ratio, credit score and income standards, you may also need to provide a “withdrawal letter,” says Nicole Rueth, senior vice president of the Rueth team at OneTrust Home Loans. “This is an additional document required for the loan that simply states your intention to use the money. It could be as simple as debt consolidation or home renovations,” says Rueth.

Another consideration is that you generally won’t get a valuation waiver with a cash refinance, adds Rueth.

How much money can you get from a cash refinance?

The key number to remember with a cash-out refinance is an 80% loan-to-value ratio, as that is the loan limit set by Fannie Mae and Freddie Mac. In other words, you can borrow up to 80% of your home’s appraised value. The more equity you have at the start, the more money you can withdraw.

Some lenders also have caps on the amount of money you can receive, even if your LTV would be less than 80%. Be sure to ask as you evaluate different lenders.

Advantages and disadvantages of cash-in refinancing

Advantages

  • Best Rates. If interest rates are lower than what you’re currently paying, or if your financial situation has improved such that you might qualify for better rates and terms, then a cash refinance might be beneficial, Grzebin says.
  • Lower monthly bills. If you decide to use cash refinance for debt consolidation, you may be able to reduce your overall monthly expenses and relieve some financial pressure. This is especially true if you have high interest consumer debt.
  • More cash. If a cash injection helps you achieve a personal financial goal, whether it’s a home improvement or paying a medical bill, a cash refinance can provide you with the cash you need. Funds from a cash refinance can also be used to buy back a share from one property to another, which is why it’s a popular tool for divorced couples.

The inconvenients

  • Too much debt. In the event that your living situation changes after a cash refinance, you could end up putting your home at risk if you can’t afford to pay the new loan.
  • Higher payout. A cash-out refinance could result in higher payments than your previous mortgage, especially if you are unable to secure a lower interest rate. “Cash-in refinances may also require a slightly higher interest rate than standard refinances,” says Grzebin.
  • Go upside down. If the value of your home goes down, a cash-out refinance could result in you owing more than the home is worth. With the current 80% LTV requirement, however, Rueth says the risk is lower now than it was before the 2008 mortgage crisis, when lenders allowed more aggressive borrowing.

Withdrawal Refinance Alternatives

If you need the cash but don’t want to go the cash-out refinance route, you have other options that allow you to leverage the equity in your home.

Home equity line of credit

A HELOC exists as a separate loan, creating a second lien on the property. It’s not really a loan, however; it’s a line of credit you can draw on if needed. Closing costs are minimal. For the first five or ten years (depending on the terms), you only have to repay the interest on the amount borrowed, or a small minimum payment. After this period, you must begin to repay the principal plus interest.

The downside is that the interest rate is variable and tied to the prime rate. “As the Fed rate goes up and it’s expected to go up more than 4%, those home equity lines of credit will go up as well. Probably up to 6% or even up to 7%,” Rueth says. “So that higher interest rate on that variable line could be painful because that mortgage payment fluctuates.”

Home Equity Loan

A home equity loan is another name for a second mortgage. You take out a second loan against the equity in your home, so you’ll have an extra payment to make each month. The appeal of a home equity loan is that you can opt for a fixed interest rate. The key to making this product work for you is to make sure you don’t borrow more than you can afford to repay.

Refinancing by withdrawal HELOC Home Equity Loan
A loan payment Two loans to repay Two loans to repay
Generally fixed rate Floating rate Fixed rate
Lump sum Line of credit to be used as needed Lump sum
Easier to manage More flexibility in how much you borrow Predictable cost
Higher closing costs Reduced or no closing costs Reduced or no closing costs

Is cash-in refinancing a good idea?

“Cash-in refinancing can be productive — even in a rising interest rate market — when long-term circumstances suggest success,” Rueth says.

For example, if you have large debts with high interest rates, consolidation could help you in the long run. “Typically in a higher mortgage rate environment you also have growing consumer debt in interest rates. So if that is the case consolidating debt into a long-term fixed mortgage product could have a lot of sense,” says Rueth. .

The other main factor when considering a cash refinance is the equity in your home. Given that home values ​​have increased significantly, this could be a good time to act for some people. “We have opportunities today that many families might not have had just two years ago,” says Rueth.