Refinance volume in the US reached all-time highs in the past several years due to mortgage rates dipping to historically low levels. While a rate / term refinance is still the most popular type of refinance in the US there is a second type of mortgage refinance that is seeing a resurgence as homeowners are sitting on large amounts of equity in their homes. That refinance is called a cash-out refinance and we will explain the pros and cons of this loan product and explore more about what is a cash-out refinance?
What is the Purpose of a Cash-out Refinance?
A cash-out refinance is defined as a mortgage loan where the homeowner is taking out an amount of cash from the equity in their home to use for things like debt consolidation or home renovations. According to CoreLogic, homeowners with mortgages have collectively seen their equity increase by a total of $2.9 trillion since the second quarter of 2020, an increase of 29.3% year over year.
In the housing boom of the early 2,000’s cash out mortgages were popular with homeowners who accessed the equity in their homes as home values increased at a healthy clip. With interest rates remaining at attractive levels and home values increasing to record levels, cash-out refinances are once again a popular choice for homeowners looking to remodel their homes or pay down high interest consumer debt.
The most common reason today for a cash-out refinance is for debt consolidation. Cash-out debt consolidation mortgages are a great way to pay off higher interest consumer debt and lower the payment on that debt by placing it in to a mortgage loan. The trade-off for the borrower is knowing that this debt will now be spread out and paid off over a 30 year period rather than potentially being paid off sooner if the debt remained on the credit card.
In addition, borrowers doing a debt consolidation cash-out mortgage must be certain that they will not fall in to the trap of running up their credit cards again and putting themselves in the same “debt trap” that necessitated the cash-out mortgage in the first place. Consolidating credit card debt on to one’s home loan should be a one-time event that should only be done when all other options for paying off that debt have been exhausted.
Another common reason for doing a cash-out refinance is to do home improvements on one’s home. With home values at record levels and housing inventory remaining low, homeowners are staying in their homes longer and remodeling their homes to their liking. Interest rates remain competitive so tapping into the growing equity in one’s home may be a smart decision if the home needs updates.
Home improvements can include a number of different projects, with one of the top home improvements being a kitchen remodel. The kitchen is one of the central gathering places in the home so remodeling the kitchen to better suit your taste is a wise investment and a good use of home improvement funds. Updating a bathroom is also a good use of home improvement funds, just make sure to remodel all bathrooms in the home if the funds are available to do so.
Here in Arizona, replacing the air conditioning units is a large cost for a homeowner so if your units are 10+ years old this may be great time to tap into your home equity to replace the old AC units with new ones. If timing allows, try to take on this project in the winter months when air conditioning companies are not as busy as over the summer and you might be able to negotiate a better deal.
How much Equity do I Need to do a Cash-Out Refinance?
For a cash-out refinance, homeowners are allowed to borrow up to 80% of the value of your home. This 80% is referred to as the “loan to value” and is calculated by taking the value of your home, less what you owe on the home, add in the amount you want to pull out as cash without going over 80% of the value of your home.
What are the Benefits of Taking Equity out of Your House?
With home prices seeing substantial increases over the past several years homeowners have substantial home equity at their disposal. Interest rates remain competitive so homeowners can tap into their equity on very favorable loan terms.
When homeowners have a need for a large amount of cash, borrowing against one’s home equity will allow you to borrow money at much better interest rates and loan terms that any personal loan or credit card. There may be a need to pay college tuition, make home improvements, or pay an unexpected expense.
Both personal loans and credit cards come with higher interest rates and typically smaller credit lines and loan balances. Tapping the equity in your home is possible to do with lower interest rates and more favorable loan terms such as a longer payback period which keeps the monthly payment low and affordable.
And if you use the cash out funds to improve your home, it may be possible to have the interest on the funds you take to be tax deductible. Of course, it is always advisable to talk to your accountant to learn what is and what is not tax deductible.
If you need more information or clarity on what type of refinance is best for you, read our informative article here to learn more about which refinance type is best for you.
What Credit Score do I Need to Refinance my House?
To do a refinance on a home, most borrowers will do a conventional loan refinance. A conventional loan refinance will be either a cash out refinance or a rate and term refinance to either lower the interest rate or shorten the term of the mortgage.
Both refinance types have credit scoring requirements that borrowers need to follow. For a conventional loan refinance, no matter what type of refinance, the minimum credit score requirement will be a 620 mid credit score. While a 620 credit score is the minimum score required to qualify to do a conventional refinance loan, ideally you will want to have your score higher than that to make the loan process a smooth one and to assist the mortgage lender with his or her loan approvals.
What Documents are Needed for a Refinance?
The mortgage documents needed to do a refinance loan are almost identical to the ones needed for a Purchase loan, but with slight differences. For both loan types, borrowers will need the standard required asset and income documents, and those documents will include:
- Paystubs
- Bank Statements
- W2 or 1099 forms
- Tax Returns
And for the home that the mortgage lender is refinancing, property documents will also be needed. That list of required documents includes:
* Mortgage statement
* Homeowners Insurance Policy
* Property tax statement
Most of these documents are readily available to those that maintain good financial records. If you don’t already have your property documents saved in a good place these are always records that are good to have stored and accessible should the need arise.
How Long Does it Take to Close on a Cash Out Refinance?
A lot of the work that is done by your Mortgage Lender is dependent upon the cooperation of the borrowers when doing not only a refinance, but any mortgage loan. The mortgage lender will need documents from the borrowers as outlined above and the lender will need to receive those documents in a timely manner to keep the loan moving along in a timely manner during the loan process.
With this said, most refinances will take anywhere from 30 – 60 days from start to finish in most cases.
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