A Beginner’s Guide to Cash Out Refinancing

Is there a home improvement project that’s been weighing on your mind? Maybe the roof is in dire need of repair, or a complete kitchen makeover that would seriously up the value of the property and your home life.

Or maybe you find yourself in a situation that requires a lump sum of money that you don’t have on hand? Like paying for college tuition perhaps?

If these scenarios hit home with you, then the solution could be cash out refinancing.

Cash out refinancing is where you take on a new mortgage loan to pay off your existing one, and in return you receive the difference in cash.

Your new loan and the amount of money you’ll get is largely determined by equity, which is the difference between how much your home is worth and any debts, or liens, you have against the home. On a conventional cash out refinance loan, lenders usually require that you borrow a total of no more than 80% of your home’s equity. This number is called your loan to value ratio (LTV).

To determine your total LTV, take your total mortgage balances and divide it by the appraised value of your home.

For example: 200,000 (Loan) / 450,000 (Home value) = 44% (LTV)

Before diving deeper into cash out refinancing, it’s worth mentioning that there are many reasons to seriously consider refinancing your mortgage outside of cash out refinancing. If you’re interested in learning more about refinancing as a whole, then check out When Is The Best Time To Refinance Your Mortgage?

Why Cash Out Refinancing

We touched upon this briefly at the beginning, but what are the reasons to take out money from cash out refinancing? People tend to use this option mainly for three reasons:

• Home improvement projects (Kitchen/bathroom remodeling, adding an extra room or attic, etc.)
• Paying off debt (consolidating debt)
• College tuition (for your children or maybe even yourself)

Remember that these are just the most common examples, and not the only valid reasons to get cash out of your home’s equity. In fact, once you receive the money in full, there are no restrictions on what you can spend it on. Though of course, this doesn’t mean you should be reckless with your spending. Cash out refinancing is best used with a plan or goal in mind of how to use the money.

Calculations

As mentioned before, equity plays a big part of determining how much you’ll receive. To calculate a rough estimate for both your new loan and the money you’ll receive, take the appraised value of your home and multiply it by 80% and then subtract your total loan. Here’s an example using numbers:

450,000 (Home value) * 80% (Max LTV) = 360,000 (Max loan total) – 200,000 (Existing Loan) = 160,000 (Gross cash)

In this example, the new loan total would be $360,000, and the gross difference you’d get to pocket would be $160,000. Again, these numbers are just an estimate of what to expect. A lender’s final numbers could look slightly different with all sorts of other factors at play. Also, you aren’t required to take out the max amount of equity possible, but it isn’t wise to use cash out refinancing to take out a small amount of money.

Drawbacks

Cash out refinancing is a process that comes with many risks that you’ll need to be ready for. Here are some of the downsides:

• Higher interest rates – Even if the national interest rate is lower than when you first got your mortgage loan, there’s a good chance that your new loan will be at a higher rate. This is because lenders view cash out refinancing as inherently riskier since you’re taking on a bigger loan. It’s not an absolute guarantee that your interest will be higher, but don’t be surprised if it is.
• Closing Costs – Just like with buying a home, getting a cash out refinance loan comes with closing costs. These costs will range between 2-5% of the new loan, and the closing process can take anywhere between 1-2 months. In other words, make sure you’re prepared to cover the costs and wait out the closing period until you receive the cash. (On that note, Dash Home Loans is a fast mortgage lender and can often get cash out refinances done in 21 days or less.)
• Bigger Mortgage loan – Though this fact is a whole part of the process, it’s important to understand that you are in fact taking on a bigger mortgage loan.

This is why it’s so important to properly plan (with a qualified mortgage coach from Dash Home Loans, perhaps?) and make sure a cash out refinance plan is the best option for you.

Requirements to Qualify

The next logical question to ask is what qualifications you need to meet before applying with a lender for a cash out refinance loan. While every situation can be unique, here are the basic 3 qualifications you’ll need to meet before filling out an application with a lender:

• At least 20% equity in your home
• DTI (debt to income ratio) of 43% or less
• A credit score of at least 620

Regarding your credit score, while you should anticipate a higher interest due to the inherent risk as mentioned earlier, if your credit score is better than when you first bought your home – and if the national interest rate is in your favor – then it may be possible to get a better interest rate with your new loan.

To Sum It All Up

A cash out refinance plan could be the right move if you need a lump sum of cash fast. But at the same time, without proper planning, a cash out refinance loan could easily become a heavy burden; leading to a bigger mortgage with a higher interest rate that could feel impossible to pay off.

This is why it’s so imperative to work with the right team. The Dash Home Loans team.

Our mortgage coaches will work with you directly, learning your unique situation and working with you to figure out if a cash out refinance loan is right for you.

And if it is, we’ll be with you through every step of the process, from helping you understand the different loan options to when you receive your equity in cash with a plan in place that you can feel confident about. If you’d like to inquire with a mortgage coach or learn more about cash out refinancing, then click here today!

*Opinions expressed are solely my own and do not express the views of my employer.