Are you trying to wade your way through the confusing world of home refinancing? Have you seen terms like “cash-out refinance” or “cash-out mortgage” and wonder if this would help you consolidate your non-mortgage debt? Read on to see if a cash-out refinance might work for you.
- Do you have a current mortgage on your home?
- Do you have equity in the home?
- Do you need cash?
If you answered “yes” to all of the above questions, then a cash-out mortgage could be an option for you.
For example, let’s say April and Peter own a house in Kansas City. They bought their home for $140,000 three years ago and owe $100,000 on the loan currently. This means they might have $40,000 in equity in their house. April wants to open a small business. She has figured the start-up costs to be around $10,000. April and Peter can choose to do a cash-out refinancing to use some of the equity they have built up in their home to start April’s new business.
This is how it works. They go to their mortgage company and get a new loan for their home for $110,000 (the $100,000 they currently owe plus the $10,000 they need for a project.) The old mortgage ($140,000 mortgage) is paid off, and they receive a new mortgage for $110,000. They can use the $10,000 cash to start their new business. The above numbers are simplified and exclude potential closing costs and fees and expenses.
Costs and disadvantages of a cash-out mortgage.
There are costs associated with a cash-out refinance. April and Peter would need to pay closing costs for their new loan. They also have to go through the process of gathering their financial documentation to go through the loan process.
To refinance a mortgage is not without risks. If a catastrophic financial event occurs in the lives of April and Peter, their home is at a greater risk since they have less equity in it.
Before you make a decision about a cash-out refinance, make sure that you understand the risks and costs.
Advantages of a cash-out refinance.
There are benefits of getting cash from a cash-out refinance. Some homeowners may use the money to consolidate non-mortgage debt. Many homeowners turn to cash-out refinance because they seek to pay down high-interest credit card debt.
In addition, mortgage debt might be tax-deductible, but credit card debt is not.
The cash from a refinance could be used as an investment to make more money. Hopefully, April will be able to earn a profit from her new business, and eventually, her business might bring in more income than the $10,000 she borrowed for her start-up costs.
What can you do with the cash from the cash-out refinance?
A cash-out refinance is not just for new business ventures. April and Peter can consolidate debt, make home improvements, or even use it as a down payment to purchase additional real estate.
Our fictional couple needs to remember, though, that they could lose their home if they don’t repay their new mortgage.
Are there any restrictions for cash-out refinance?
Just like the first time they borrowed money for their home, April and Peter need to have a minimum credit score. The better their FICO score, the better rate they might receive on their cash-out mortgage.
April and Peter need to have owned their home for at least a year.
Finally, they need to have a loan-to-value ratio that’s a maximum of around 80 percent. This is figured by this simple formula:
Mortgage Amount Owed / Appraised Value of the Property
$100,000 (amount they owe) / $150,000 (current value of the property) = 67 percent loan-to-value ratio. This loan-to-value ratio might qualify for a cash-out refinance. You can check out a mortgage calculator to see if refinancing makes sense for you.
Which properties are available for a cash-out refinance loan?
The property can be occupied by the owner for a cash-out refinance, but he or she does not need to be the primary resident.
As long as homeowners meet lender requirements, and do not put their home on the market during the process, any property might be eligible.
