Minimalist LIfestyle Archives - Hanover Mortgages

August 23, 2021

FHA Streamline Refinance [Rates, Closing Costs & More]

FHA streamline refinancing is a quick and simple way to improve the terms on your home loan — but it only applies to those who have already taken out an FHA loan to finance the purchase of their property. This type of home loan also has different rates, requirements, and costs when compared to traditional mortgages.

Homeowners with FHA loans may wonder whether a streamline refinance is the right financial move. In this post, we’re walking you through how FHA refinancing works, what you need to know about it, what costs to expect, and how they stack up against using a traditional mortgage refinance.

Take a look at the topics we’ll cover here:

If you’re new to FHA loans and refinancing, we’ll start with some simple definitions. And if you already know what you need and are curious about costs, and pros & cons, you can skip ahead.

(Note: If you’re looking for more general information on refinancing, be sure to check out our mortgage refinance guide for an in-depth look.)

What is an FHA refinance?

In order to understand an FHA refinance, let’s first explain what an FHA loan is. When you take out a mortgage, your lender — usually a bank or other lending agency — takes a risk on you. They’re betting that if they give you money to purchase property, you’ll be able to pay it back within a set timeframe. That’s why they charge interest: to earn money from the risk they’re taking. It’s also why lenders require extensive credit checks, background checks, closing costs, and fees.

FHA loans work a little differently. One misconception is that the FHA issues the loans directly. In fact, you can still get an FHA loan from a bank or other lender; they just have to be FHA-approved. What makes a mortgage an FHA loan is that it is insured by the FHA, the Federal Housing Administration.

Being insured by the FHA means that lenders are more willing to give you favorable terms, like a lower down payment, lower closing costs, and less strict credit score requirements than you might find when applying for a traditional mortgage.

What does refinancing mean? When you refinance a mortgage, you negotiate the terms on your mortgage debt. Usually, people refinance their mortgage to shorten or lengthen the repayment period, get a lower interest rate, secure other more favorable conditions, or cash-out on home equity to complete a project.

FHA loans can also be refinanced by negotiating a new FHA loan, although the reasons for your refinance may be more restricted than with a traditional mortgage; for instance, you may not take out more than $500 in cash when taking out an FHA refinance. One popular option that people seek when refinancing an FHA loan is a streamline refinance.

FHA streamline refinance

An FHA streamline refinance is a fast and simple way to refinance an FHA loan. HUD.gov specifies that FHA streamline refinancing doesn’t mean you’ll pay any less in costs, just that the refinancing process has limited documentation and underwriting requirements.

An FHA streamline refinance does come with a basic set of requirements, however. To get FHA streamline refinancing, you’ll need to make sure that you meet the following conditions:

You have an FHA-insured mortgage. If you have a traditional mortgage acquired through a bank, credit union, or lending agency and that loan is not FHA-insured, then you will be ineligible for an FHA streamline refinance. Instead, you may want to consider a traditional mortgage refinance.
Your mortgage payments must be current. If you are delinquent on your mortgage payments — that means you’ve missed payments or underpaid — you will not be eligible for an FHA streamline refinance. It’s also important to ask the individual lender what their bank or agency’s policies regarding delinquency are, as some lenders may have more strict requirements than others.
The refinance results in a tangible benefit to the borrower. The HUD website specifies that the loan must prove to be a tangible net benefit to the borrower in order for you to qualify. This might mean that you end up paying less overall, or you end up with a more favorable repayment period for your specific financial situation.
You may not take out more than $500 in cash while refinancing. Some traditional mortgage refinancing options, like cash-out refinancing, allow borrowers to take out a portion of the equity in their home as cash to be put toward high-cost expenditures or projects of their choosing. This is not an option for FHA streamline refinancing at amounts over $500.

Streamline refinancing is a good option for some people in select circumstances. In order to make a more informed decision about whether an FHA streamline refinance is the best option for your mortgage, it’s important to know the costs, as well as the pros and cons.

FHA streamline refinance closing costs and other expenses

As with any mortgage or mortgage refinance, there are a number of costs that come along with taking out an FHA mortgage or an FHA refinance. If you’re considering an FHA refinance, be sure to review these costs before making any final decisions, and weigh them against the potential costs of other financing and refinancing options.

Interest. Like other home loans, there is interest attached to FHA mortgages. FHA streamline refinance rates can vary significantly depending on factors like your credit score, the individual bank, credit union, or lending agency you work with, and the economic conditions at the time — the way the economy is doing can raise and lower interest rates. Sometimes, FHA streamline refinance rates can be higher than traditional mortgage refinancing, so be sure to speak with a professional to learn about your options before committing.
Down payment. Most mortgages require you to make a down payment when applying, and the same applies for FHA mortgages. The good news is that these are generally low, which is one of the reasons why many seek out FHA mortgages. Additionally, depending on the specific loan product and the lender, you might not owe any money down when acquiring an FHA refinance.
Closing costs. There may be closing costs applied to your FHA streamline refinance depending on the specific lender you work with. Some lenders offer “no cost” refinancing, meaning that the borrower does not pay any closing costs when refinancing their FHA loan. However, the lender may increase the interest rate to offset the lack of closing costs, so be sure to thoroughly research your lender’s FHA refinancing before deciding. It’s also important to note that the closing cost amount cannot be added directly to the total cost of the mortgage for a streamline refinance.
Mortgage insurance. Mortgage insurance premiums (MIP) are an extra amount that borrowers must pay to secure a mortgage when their down payment is low; for traditional mortgages, that’s typically below 20%. Mortgage insurance may be applied to your FHA loan depending on your downpayment and other financial factors like your credit score.
- Note: The FHA may offer partial refunds on some mortgage insurance when you sign up for an FHA streamline refinance. To find out more, use the FHA MIP refund chart to get a better estimate of your potential refund.

To find out more about possible costs and factors that go into refinancing, read our guide to the mortgage refinance process.

FHA refinance: pros and cons

As you consider your refinancing options, be sure to carefully think through the FHA streamline refinance pros and cons.

Pros

Potential for more favorable terms or lower cost
Typically quick and easy to complete
Possible mortgage insurance premium refund
Lower credit requirements than a traditional mortgage refinance

Cons

Interest rate may be higher depending on a number of factors, including the specific lender you work with and other factors
Requirements, like FHA streamline mortgages being restricted to FHA loans, and the requirement that you cannot be delinquent on your mortgage, may exclude some borrowers
Those looking for a cash-out refinance to fund home improvements or other large expenses may not be able to secure the funding they need through an FHA refinance

As with many financial products, the bottom line is that whether an FHA streamline refinance works for you depends on your specific financial situation. Understanding the specifics of your personal finances, where you are in your mortgage payments, and what options your lender has available is critical.

Key FHA streamline refinance takeaways

Considering an FHA home loan or FHA streamline refinance? Keep these key takeaways in mind as you continue your research and assess what options suit your personal financial profile best.

FHA loans are mortgages approved and insured by the FHA; they have easier-to-meet requirements than many traditional mortgages.
FHA streamline refinancing can help you secure more favorable terms on an FHA loan while also giving you the opportunity to reduce the amount you owe on mortgage insurance premiums.
Streamline refinancing is quick and requires minimal documentation, but FHA streamline refinancing closing costs may still be applied; sometimes, these are factored into your new interest rate.
Always research your options before settling for any particular mortgage or refinance product. Often, it’s smart to shop around before committing, that way you know you’re getting the best deal that you can get in light of your financial circumstances.

Sources:

HUD.gov | Investopedia

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August 23, 2021

How to Financially Prepare to Buy Your First Home

Home-buying season is coming up. With the warmer weather approaching, home buyers are eagerly waiting to find their dream place.

Since buying a house is typically the biggest purchase you’ll make, preparing your finances can give you a significant win. For example, if your credit score is high enough, you can get more competitive rates with mortgage lenders.

Besides saving up for the down payment, there are other costs with the home buying process.

If you’re looking to become a homeowner soon, let me show you how to prepare your finances so that you can get a better deal on your house and still have money left over for other expenses!

Buying a House: More Than Just the Down Payment

While most attention is given to getting a good-sized down payment ready, there’s more involved than just your mortgage payments.

Lenders are looking at factors like income, debt to income ratio, but a huge factor is also your credit score. Your credit score is based on your credit reports. You have three credit reports and scores from each of the credit bureaus – Experian, Equifax, and TransUnion.

Want the Best Rate? Boost Your Credit Score

While the exact algorithm isn’t publicly disclosed, we do know the key factors that go into calculating your score.

35% Payment History
30% Amount Owed
15% Length of Credit History
10% New Credit
10% Types of Credit

Looking at how things are weighted, if you want to make the biggest impact on your credit score, you need to focus on your payment history and keeping your debts in check.

Let’s see how you can improve them which can help you boost your score before you start your home search.

The first thing you need to do is to get a copy of your credit report and make sure that it is accurate. Believe it or not, there is a chance that your report may have a mistake. In fact, it’s been estimated that more than 20% have an inaccuracy on their credit report. While it might be a minor detail like a misspelled name, if there’s any error with your payments or if it shows an open account that isn’t yours, that can really hurt you.

Because of the pandemic, you can now get your credit reports for free weekly over at AnnualCredit Report.com. If you do find a problem, you can then file a dispute with the credit bureau. In the meantime, keep your payment history in tiptop shape by automating them using your bank or credit union’s bill pay system.

You also want to keep in mind since lenders are assessing your finances to make sure you can handle a mortgage, you’ll want to make sure that your debt to income ratio is fairly low. Paying down your high-interest debts can be a huge win. If they are credit cards, after you pay them off, you may want to keep the accounts open at least until after you’ve bought your house. Lenders typically look favorably for those who have unused lines of credit. If you want to avoid the temptation of using it, you can tuck away your credit cards in an inconvenient, but safe place around your house.

Figuring Out How Much House You Can (Comfortably) Afford

Now that your credit report is accurate and your score has improved, it’s time for the next step in preparing your finances – finding out how much house you can afford. Besides having your mortgage lender calculate how much you can afford, it is also wise that you run the number yourselves. Chances are you have other goals than just buying a house.

When we were house hunting for our first place, we ran the numbers and then we checked them against what the lender had. With their calculations, we could ‘afford’ a significantly more expensive house. We looked at our number again and quickly realized if we went with their maximum budget, we’d be able to buy a house, but nothing else.

You may be thinking the same way. You’d love to buy a house, but you also want some money left over to enjoy it and other goals. You won’t be able to achieve them if your budget is maxed out on your house. You need to see for yourselves what you’re comfortable with so you can be a homeowner and still hit your goals. So how do you find out how much house you can afford?

The rule of thumb is that you should try to keep your mortgage no more than 2 ½ to 3 times your annual income. Let’s say that your family’s annual income is $65,000. Using that guideline, you’d be looking at homes around $163,000 – $195,000. If you’re a family making $120,000, then you can enjoy hunting houses between $300,000 – $360,000 and still have some money left over for other dreams.

Once you know how much you need to save you can use features like Mint’s Goals to keep track of your progress with the down payment. I’ve noticed that having a visual reminder has motivated many families towards their goals. As you hit certain milestones, have a small celebration.

Why Your Down Payment Matters

One of the biggest reasons why’d you like a larger down payment is to avoid paying private mortgage insurance (PMI). That gives lenders and extra assurance with the money they’re lending, but it can be an unnecessary weight on you.

Start automating transfers into savings with each payment, even if it’s a smaller amount than you hoped. You can then beef up your down payments by redirecting any windfall income (like a bonus, stimulus check or tax refund) into your savings. Having a bigger stash can be a huge help when you buy your home!

Closing Costs: What You Need to Know

You’ve saved your down payment, found an agent, and have found your dream house. Your offer was accepted. Before you celebrate, keep in mind there are some more expenses that come with the closing process.

I pulled out the paperwork from when we were buying a house a few ago and here’s what I found:

Appraisal
Home Inspection
Homeowners’ Insurance
Transfer Taxes
Underwriting Fee
Loan Discount Points
Pre-Paid Interest
Property Tax
Pest Inspection

It probably seems like too much and to a degree, I can understand. Some of these fees are non-negotiable and while others aren’t. However, you want to be careful with which expenses you try to save on. Skipping a home inspection is not a smart move, even with a new build. Believe me, we’ve been there.

When we bought our first house, it was a new build and so we thought it would be fine to skip the inspection and save some cash. However, new builds don’t guarantee good work. We had small mistakes become big headaches and by the time we sold our place about five years later, we had to have all but one of the windows replaced.

Would the inspection help us catch all of these things? No, but it would’ve given us a clearer idea of expenses to expect. With our second house, we did get an inspection and not only did it help us understand what future projects we’d need to tackle, but we were also able to use it as a negotiation tool.

Your Thoughts

I hope these tips give you a jumpstart towards your goal of becoming a homeowner. I want you to buy a home that you love, but allows you to pursue all of your financial and family goals!

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March 10, 2021

What is a Hard Money Loan & How Do They Work?

Hard money loans are a way for borrowers to take out a real estate loan without having to work with traditional lenders, like banks, credit unions, or mortgage agencies. Traditional lenders usually base their willingness to lend you money, and the interest rate they’ll charge you, on factors like your income and credit score.

➔ Hard money definition: a hard money loan is a loan borrowed against tangible collateral, rather than by using a credit assessment

However, for those who want to close on property sale quickly, or those who have a low credit score, hard money can be an enticing alternative. In this post, we’ll cover the basics of hard money loans, like how they work, what you can use them for, and some of the advantages and disadvantages of using a hard money loan. You can skip ahead to any of those topics by using the links here:

Before you can decide whether a hard money loan is a reasonable option for your situation, it’s good to know how they work. Let’s take a look at that now.

Hard money basics

It’s easiest to understand how hard money loans work by contrasting them with traditional loans or mortgages. Few people have the liquid cash on hand to simply buy a home outright. So, instead, they take out a loan from a bank or credit union. You purchase the property with the money they’ve lent you, then you make payments back to them over the course of ten to thirty or so years, all as part of a manageable debt repayment strategy.

Traditional mortgages come with some requirements. For instance, banks want to know that you’re a reliable lender. They can assess that by looking at your credit history, your personal track record when it comes to borrowing money (say, for college, or to buy a car). This is measured by your credit score.

Your credit score lets banks and other agencies know how likely you are to pay the money they lend you back, based on how reliably you’ve done that in the past. The higher the score, the more likely you are to pay your borrowed money back — and, crucially, the more likely you are to get a reasonable interest rate from the bank.

How do hard money loans work?

Hard money loans, on the other hand, usually do not work by assessing your past credit. Instead, they work by taking collateral, or hard money, against the loan. They won’t check your credit, but they will ask that you offer something you own in exchange if you cannot pay back the loan. What is hard money? Basically, a tangible asset, like gold, silver or property. Here are a few examples of items that might be used for collateral:

Any real estate you may already own
Equity in property
Your car or other vehicles
Expensive jewelry, watches, or gold and silver items
Savings accounts
Investment accounts and retirement accounts
Cash

If you fail to keep up with payments, the loan agency may have the right to possess the things that you’ve offered up as collateral. That’s where the term hard money comes from; it’s borrowed against a tangible asset, rather than based on your merits as a borrower in the past.

Because the hard money lending agency typically does not perform an extensive check on your credit history, the process can be completed and your loan approved much more quickly. These loans are also sometimes appealing for those with poor credit, such as those who have defaulted on a loan in the past, or those who have been through bankruptcy.

Importantly, hard money loans also have comparatively high interest rates. In fact, rates can be as high as 15%, as opposed to traditional loans, which are often closer to 4%. That makes the loans fairly expensive, especially once other expenses like closing costs, service fees, and signing fees are factored in.

Most hard money loans have shorter repayment periods, however — anywhere from one to five years, meaning there is less time for the interest on the loan to accrue. Though they are expensive, they do have their purposes. Let’s go over a few cases where borrowers might use a hard money loan.

What are hard money loans used for?

Hard money loans are most often used to buy property. Though in most ordinary cases, a traditional mortgage is likely a more financially stable option, there are times when a hard money loan may come in handy.

One common use for hard money loans is in real estate investing, and specifically house-flipping. That’s when someone purchases a run-down home, fixes it up, then sells it, hopefully for profit. Hard money loans can be useful in that case because the term that borrowers have the loan is short — just until they’re able to fix and flip the property, then sell it.
A cash bidding battle may also be a case where a hard money loan can be handy. Say you absolutely want a piece of property, but don’t have the time to go through the intensive and time-consuming mortgage application process. A hard money loan can be approved quickly, getting you the cash you need to put down a competitive offer, and so can be used as a bridge loan. There are risks associated with this, though, which we’ll cover in the next section.
Hard money loans may also be used by those who simply want to purchase property but do not have the credit to afford a traditional mortgage. If, for whatever reason, you’re flush with owned tangible assets but have a lackluster borrowing history, a hard money loan could be a plausible workaround. This may be a higher-risk option, however, because, unlike a traditional mortgage with a 30-year repayment term, a hard money loan may only have a 3-year term.

Next, let’s cover the pros and cons that come along with a hard money loan.

Pros and cons of hard money loans

As with any financial product, hard money loans come with pros and cons. Before getting serious about looking into a hard money loan, it’s smart to be thoroughly versed in their advantages and disadvantages. Let’s take a look.

Pros

Hard money loans are accessible to those with lower credit, making them more widely available than a traditional mortgage might be. This would mostly apply to a case where a borrower had a lower credit score, but possessed a number of high-value assets that can be used as collateral when taking out the loan.
They typically have faster approval and disbursal times because loan agencies do not need to perform an extensive credit check. So, if you need cash ASAP, you’ll likely have access to it more quickly than you might when using other loans.
Some hard money loans offer flexible repayment schedules. Because they are borrowed against tangible assets, and because you’re working with a smaller company rather than a larger corporation, the agency may allow some wiggle room when it comes to your repayment plan.

Cons

As noted above, hard money loans have notoriously high interest rates. If you’re not certain you can comfortably pay back your loan within a short amount of time, you may end up paying a huge sum in interest — much more than you would with a traditional home loan. Not sure how having a long-term high interest rate will affect your finances? Check out our explainer on debt and your worth.
Hard money loans by their very nature require you to risk your personal assets. If you’ve put your priceless family heirlooms or childhood home up for collateral, take out a hard money loan, then are unable to pay it back, you risk losing those belongings to the loan agency.
Using a hard money loan for house flipping may be risky due to market shifts. As with any business venture, house-flipping requires taking on a certain amount of risk. If something happens and the housing market tanks after you’ve taken out a loan for a house-flip, you could be left without enough money from the sale of the house to pay off the loan. Risk is unavoidable, but it’s always smart to make sure you’re not taking on too much real estate risk.

Because of these fairly significant disadvantages, it’s always advisable to approach hard money loans with caution. Typically, if you can comfortably consider a traditional mortgage, that tends to be a safer alternative when your aim is purchasing property. Banks and credit unions tend to be more reputable than many hard money lending companies, and the amount you’re likely to spend in interest is substantially lower.

Hard money loan takeaways

Before you go, keep these hard money loan takeaways in mind, and remember to consider them before taking out a hard money loan in the future.

Hard money loans are usually real estate loans used to purchase homes or land quickly, as these loans do not take as much time to complete as a traditional mortgage.
Instead of using your credit score and other financial factors to assess trustworthiness, hard money lenders lend you money against collateral.
Hard money loans typically have much higher interest rates than mortgages, frequently in the double-digits.
Many use hard money loans to fix and flip houses, though this comes with some risk.
They are also useful to those with lower credit, but it’s important to remember that hard money loans can be highly risky. Check out our post for tips on how you can improve your credit score.
Ultimately, they have specific use cases where they may be a plausible option, but on the whole carry a significant amount of risk, and are expensive.

Sources

Investopedia | Debt.org

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March 8, 2021

Should You Refinance Your Mortgage While Rates Are Low?

The mortgage industry (and interest rates) have a somewhat complicated relationship with the rest of the overall economy. Generally speaking, when the economy is doing very well, the Federal Reserve will start raising interest rates. This can help to try and ward off inflation which is not great for the economy. Conversely, when overall economic conditions are poor, the Federal Reserve will LOWER the interest rates, in an attempt to spur economic growth. Since the interest rates on most mortgage products are (directly or indirectly) tied to the overall Federal Reserve interest rate, these actions have a pretty significant impact on mortgage interest rates.

Mortgage rates can fluctuate daily or even hourly, so it’s good to have a basic idea of what you want to do and what might make you want to refinance. With mortgage rates at historic lows, let’s take a look at what that means and whether you should refinance while rates are low.

Mortgage rates are at historic lows

The mortgage market is a fairly complicated market with several different types of mortgages available. So when you hear that mortgage rates are at “historic lows”, it’s important to understand what type of mortgage is being talked about. Usually, the 30-year fixed mortgage is the loan product that is considered the “standard” mortgage. So if you hear about rates “dropping”, you’re usually hearing about the 30-year fixed. It is true that usually (but not always!) rates for different types of products rise and fall together.

(SEE ALSO: What is a “Good” interest rate?)

It was not uncommon in the 1970s or 1980s to see mortgage rates with double-digit interest rates. Since that time, interest rates have generally steadily dropped, to a low around 3.5% in 2012. Mortgage rates fluctuated in the 3-4% range for the next several years before rising to around 4.5% in 2018 and 2019.

The recent coronavirus pandemic has affected the housing market and sent rates on the 30-year fixed mortgage down under 3.5%, around the lowest those rates have ever been.

Should you refinance to a 30-year mortgage?

As the name implies, a 30-year fixed mortgage will lock in your interest rate for the duration of your loan. You’ll have 360 monthly payments, all of the same amount. The exact amount you pay will depend on the amount of your loan, the duration and the interest rate. You can use our Loan Repayment calculator to find out the exact amount of your monthly payment. Keep in mind that that monthly payment amount will not include your property taxes or home insurance. Your lender may require that you set up an escrow account, or else you’ll need to make sure to budget for those expenses on top of your monthly mortgage payment.

The 30-year fixed mortgage will usually give you your lowest monthly payment. In fact, even if you currently have a 30 year fixed mortgage, you will likely save on your monthly payment by refinancing now. That is because of 2 reasons – the rates are likely lower than when you first got your mortgage and because you’ve paid down your mortgage balance so the amount you’re refinancing is less.

Should you refinance to a 15 or 20-year mortgage?

Another option to consider when refinancing is to refinance to a 15 or 20-year mortgage. A mortgage with a shorter term (like 15 or 20 years) will usually have a lower interest rate than the 30-year fixed mortgage. However, because the shorter term means there are fewer payments, your payment may still go up.

If you’re currently on a 30-year mortgage, you’ll likely (but not always) find that the monthly payments on a 15 or 20-year mortgage will be higher. The good news is that your mortgage will be paid off 10 or 15 years sooner! Overall you’ll pay quite a bit less in interest.

An example of refinancing to a shorter-term mortgage

To illustrate the types of choices you have with refinance, let’s look at an example. Our fictional homeowner bought her house 5 years ago with a mortgage of $250,000, and took out a 30 year fixed mortgage. Her monthly principal and interest payments have been $1,267 per month, and after 60 payments, her mortgage balance is now $228,305.36 with 25 years remaining.

She’s looking to refinance with today’s low rates. We’ll say that her closing costs will make her new loan payoff amount $230,000. Again using our Loan Repayment Calculator, here are some options she could consider:

A 30 year fixed loan at 3.5% – monthly payments would be $1,033.
A 20 year fixed loan at 3% – monthly payments would be $1,276.
A 15 year fixed loan at 3% – monthly payments would be $1,588.

You can see that refinancing to another 30-year mortgage would drop her payments by $234 each month. That comes at a cost of adding 30 more years to the total time it takes to repay. With a 20 year loan, her payments only go up $9 per month but she shaves 5 years and tens of thousands of dollars of interest over the course of the loan. A 15-year loan would pay even less interest but at a cost of increasing the mortgage payment by $321 each month.

Of course, every situation is different but hopefully, this can serve as a guideline to help you as you make your own decisions about refinancing.

The case against refinancing

Even though mortgage rates are at historic lows, refinancing is not right for everyone. Here are a few cases where it might not make sense to refinance, even if today’s interest rates are lower than the rate on your current mortgage:

You’re not sure if you’ll be in your home long term. Refinancing does come with some upfront costs, and if you won’t be in your home long enough to pay them back, it might not make sense
Your credit score or financial situation has taken a recent hit
You want to take advantage of some of your home’s equity with a home equity line of credit.
You don’t have enough money to pay the upfront closing and other costs associated with a refinance. If this is the case, see if it might make sense to roll those costs into your new loan.

For even more information about the pros and cons of refinancing, check out our list of 8 refinancing tips

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If you’re a homeowner looking to take advantage of the equity you’ve built in your home, you might consider how a cash-out refinance could help you meet your financial goals. Like any financial decision, it’s best to get a good look at how this might impact your finances as a whole. In this post, we’ll answer the following questions, and more.

What Is A Cash-Out Refinance?

A cash-out refinance is a loan that allows homeowners to use the equity they’ve built up in their home to take out a lump sum of cash to help take care of expenses, such as home repairs, improvements, or to pay off high-interest debts. Cash-out refis can technically be used for whatever the borrower pleases, but certain uses may be more beneficial than others.

Why Do People Refinance?

There are several reasons people choose to refinance their mortgage with a cash-out refinance or another refinancing method. Here are a few of the most common:

Reducing Your Interest Rate: Refinancing your loan could help you secure a lower interest rate than you had when you got your original loan – especially if your credit score has improved. When you refinance with a lower interest rate, more of your monthly payment goes toward the principal rather than interest, which could also help you pay off your loan quicker!

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Lowering Monthly Payments: With 35% of homeowners struggling to pay their mortgage, it’s no wonder people consider refinancing for a lower rate. A refinanced loan can help make your mortgage payments more manageable by lowering your monthly balance. This can give your budget more flexibility, but keep in mind, it could mean that you’re extending the lifetime of your loan since you’ll likely need longer to pay it off.
Adjusting Loan Type: If you’re unhappy with your current mortgage, refinancing it could make managing your finances easier. Let’s say you have an adjustable rate mortgage, but you’d prefer to have a fixed-rate mortgage – or vice versa – a refinanced mortgage could get you the loan type you want. Cash-out refis typically have fixed interest rates.
Consolidating Debt: Another potential benefit a refinanced mortgage can offer is the ability to consolidate your debt. Since refinances typically have lower interest rates, they can be used to pay off high-interest debts, such as credit card balances.

Use Home Equity: The most common reason people use cash-out refinances specifically, is that they allow you to gain access to cash quickly. If you need to make some repairs, or want to increase the value of your property, this extra money can help you cover the expenses.

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How Does A Cash-Out Refinance Work?

Now that you know the basics of cash-out refinances, let’s take a closer look at how they actually work.

Cash-out refinances allow homeowners to take out between 80 – 90% of their home equity.[1] Equity can be earned through the following methods:

Your home increases in value.
Each time you make a mortgage payment, you gain more equity in your home.

To qualify for a cash-out refinance, lenders will expect you to have a certain amount of equity built up in your home. (We’ll discuss more on how you can apply for a cash-out refinance a little later on in this post.)

When you get a cash-out refinance, the lender allows you to convert the equity you’ve built in your home into cash in exchange for a larger mortgage. Unlike a second mortgage, a cash-out refinance is a single, larger loan that pays off and ultimately takes the place of your original mortgage. When you pay off your original loan, your relationship with that lender is terminated and you move forward with your refinanced loan. In other words, the refinanced loan is used to pay off your first loan and now you’ll need to pay off the remaining balance with your new lender.

Let’s take a look at an example to help you get a better understanding of how cash-out refinances work:

Hunter bought a home for $450,000 and has paid off $100,000 of her original mortgage, leaving her with a balance of $350,000. She has an electrical issue that will cost her $5,000, and she also wants to renovate her kitchen to help increase the value of her home, which will cost $30,000. So, she’ll want to borrow a total of $35,000 via cash-out refinance.

Remember, Hunter owes $350,000 on her mortgage so if she takes out a cash-out refi, her new mortgage is:

$350,000 + $35,000 = $385,000

Pros And Cons Of Cash-Out Refinances

Your home is likely one of the biggest investments you’ll make in your lifetime, so it’s important to think critically before deciding if you should take out a cash-out refinance. Here are some of the pros and cons you might want to consider before following through with a cash-out refinance.

Pro: You Can Make Home Improvements And Renovations

You can use the money you take out from a cash-out refi to reinvest in your home by making improvements to your property. From leaky faucets to adding amenities, cash-out refinances can be a great way to add value to your home.

Pro: You Can Consolidate Debt

Another way you can use the borrowed funds from a cash-out refinance is to help you consolidate high-interest debt, like credit cards.

Pro: You Can Get A Lower Interest Rate

As we mentioned before, getting a lower interest rate is one of the main reasons homeowners choose to refinance their mortgage. If you’ve built up equity in your home and raised your credit score, you may be able to secure a much lower interest rate than your original mortgage. This means more of your monthly payments go toward paying off the principal rather than interest payments.

Con: You Still Have To Leave Equity

Cash-out refinances don’t enable you to take out all of the equity you’ve built in your home. Lenders typically require homeowners to leave 15-20% equity in their home. This means that you should consider whether the amount of equity you can take out is enough to accomplish your financial goals.

Con: Associated Fees

To take out a cash-out refinance, you’ll likely need to pay several associated fees which, depending on the cost, could mean it might not make financial sense if you don’t plan on staying in the home long enough to break even or recoup that cost. Here are some of the fees you might expect to pay when refinancing:

Appraisal fees
Closing costs
Attorney expenses
Credit report fees

Con: Changing Loan Terms

When you refinance your mortgage, you’re replacing your original mortgage with an entirely new one. This means your interest rate and loan terms (maturity date, monthly payments, etc.) are all likely to change. Ideally, these modified loan terms would work in your benefit, but it can be challenging for some homeowners to adjust.

Con: Risk Of Foreclosure

If you opt for a cash-out refinance, you’re putting your property on the line in favor of quick cash because cash-out refis use your home as loan collateral. This means that if you fail to make your loan repayments, you could run the risk of having your home foreclosed.

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How To Apply For A Cash-Out Refinance

If a cash-out refinance seems like the right move for you, here are a few tips to help you apply.

Check the requirements: Lenders each have their own set of criteria for approving cash-out refinances, so before you apply, you might want to see how your financial profile stacks up to their guidelines.
- Lenders typically require a credit score of 620 or higher for cash-out refinances.
- Certain cash-out refis, like Fannie Mae loans, require a debt-to-income ratio of less than 45%.
- To take a cash-out refinance, you’ll need to have equity in your home and your lender may even require you to have a minimum amount. However, keep in mind that you cannot access all of your equity, unless it’s a VA loan which allows you to cash out 100%.
Consider how much cash you need: As we mentioned, your lender will only allow you to take out a certain percentage of your home equity, meaning that there’s a limit on how much cash you are able to take out. If you need $35,000 to complete the renovations that you need, but you can only borrow $20,000, a cash-out refi might not make the most sense for your current situation.
Gather supporting documents: Your lender may request certain supporting documents (in addition to your credit report) before approving you for a loan. It’s a good idea to collect these documents ahead of time in order to expedite the process. Some of the documents you may need include:

○ Bank statements

○ W-2s

○ Pay stubs

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Key Takeaways
- A cash-out refinance is a loan that allows homeowners to convert their home equity into cash.
- Cash-out funds can be used to cover any expenses, but are often used to help homeowners reinvest in their property.
- Another way cash-out refis can be used is to pay off high-interest debts like credit card debt and student loans.
- Cash-out refinances offer several potential benefits, but there are also some potential drawbacks to consider, such as:
○        Risk of foreclosure

○        Changing loan terms

○        Associated fees

Is a cash-out refinance right for you? It depends. Using this guide, you can consider some of the potential risks and rewards of refinancing your mortgage. If you’re not sure if a cash-out refinance is the best move for your financial situation, consider seeking the help of a financial expert for more tailored advice!

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What Is A Cash-Out Refinance?

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Pro: You Can Make Home Improvements And Renovations

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Con: You Still Have To Leave Equity

Con: Associated Fees

Con: Changing Loan Terms

Con: Risk Of Foreclosure

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