If you need a substantial amount of cash to make a significant purchase or pay off debt, many articles online will tell you something similar: sell your stuff. Get rid of your old electronics, furniture, trinkets, and other things you don’t really need via a big online garage sale, and hope the profits make a dent.
While decluttering is fine, nothing you can sell might be worth enough to cover the funds you need. Your old couch might get you $200, at most. But you know what you own that’s valuable and don’t even need to sell? Your house.
Or at least, your home equity. You own however much of your house proportional to how much of your mortgage you’ve paid off. Obviously, you need your house to live in, which is why instead of selling it, you might consider cash-out refinancing.
Basic Cash Out Refinance Rules
Traditional mortgage refinancing entails swapping out your current loan for a new one with better terms (such as lower monthly payments or a lower interest rate).
A cash-out home refinance, however, means you replace your loan for one that is worth more. It pays off your previous loan, and you pocket the difference as cash to use (usually) however you wish, such as paying for home improvements, higher education, other loan payments, or something else. This is why your home equity—the amount of your mortgage you’ve already paid—matters.
If you’re confused about the difference between a cash-out refinance vs. a home equity loan, the former is a replacement loan, while the latter is a secondary loan. In other words, refinancing means you’re changing one out, and a home equity loan is an additional loan on top of the one you already have.
Before you start searching for a lender who is willing to work with you, here are some important cash-out refinance rules to keep in mind:
1) Your New Loan Can Be Up to 80% of Your Home’s Equity
Unfortunately, you can’t cash out the entirety of your home equity. The most you can take out is 90%, usually around 80%.
Say your home is worth $250,000, and your mortgage balance is $150,000 (meaning you’ve paid off $100,000, which is how much equity you have). You can refinance your home for a new loan worth $200,000, for example, pay off your balance, and then pocket $50,000 before closing costs. $200,000 will most likely be the maximum amount your lender will allow you to borrow because it’s 80% of your home’s value.
2) Your Existing Contract Might Limit When You Can Refinance
This scenario might not be the case for everyone, but some mortgage contracts stipulate when you’re allowed to refinance. If you have just purchased a new house, for instance, you may have to wait a period of time before you can exchange your mortgage for a new loan. Double-check your current agreement to find out if you can refinance when you want to.
3) You Need to Meet Certain Requirements
Not everyone can cash-out refinance. Different lenders enforce different criteria, but you’ll need to meet a few requirements before you can swap out your loan for a larger one and pocket the difference, such as:
- You need to have at least 20% home equity;
- An LTV (loan-to-value) ratio of 80% maximum;
- A minimum FICO score of 620 (unless you’re borrowing an FHA or VA loan);
- And a DTI (debt-to-income) ratio of around 40%.
Again, these cash-out finance requirements may differ between lenders, so you might need a higher or lower credit score or DTI, depending on who you’re borrowing from.
4) Some Kinds of Cash-Out Refinancing Are Only Applicable to Certain Situations
Another kind of refinancing option is a limited cash-out refinance. This kind of loan means your new mortgage is only slightly higher than your previous one, so the difference you pocket won’t be as substantial — you’ll only get a few thousand dollars at most.
Limited cash-out refinances can only be used for specific situations, such as consolidating two mortgages into a single loan, paying off a HELOC (Home Equity Line of Credit), paying closing costs of refinancing, or repaying energy-related loans.
5) You May Have to Wait Between Refinances
You can legally refinance your home as many times as you want, but you do have to meet the requirements. For instance, you might have less equity than you realize after a previous refinance, which means you may not have the required 20% to do so again.
Before you decide to cash-out home refinance for the second or third time, consider whether you still meet the previously mentioned credit and debt requirements. Most lenders also require you to wait at least six months after closing before you can refinance again.
We’ve discussed some essential cash-out refinance rules, but it’s necessary to consider how the process would affect your financial health. A cash-out refinance has its advantages, but it’s still debt, so talk with a financial advisor before deciding if it’s right for you.
Please note, the material collected in this blog is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or Services.
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