Studies show that more than half of Americans have less than $1,000 in their savings account.
If this applies to you, how do you anticipate covering the cost of major life events, from the unexpected to the planned?
If you need money to help foot a big bill, a mortgage cashout refinance can help. This strategy allows you to borrow money from the equity you’ve built into your home, often at a lower interest rate than you’ll find in other loans.
Today, we’re sharing how this process works, along with some of the best ways you can put your cashout refinance to good use.
Ready to learn more? Let’s get started!
What Is a Cashout Refinance?
Pursuing a cashout refinance? You’ll begin by taking out a loan that’s larger than your current mortgage; the exact amount over your current mortgage will be determined by how much equity you have in the property. In most cases, you can borrow up to 80% of the current value of your home for a cash-out refi. Your new mortgage will pay off your old one, leaving with extra cash that you can apply to help meet certain financial goals.
Let’s use real numbers to simplify the concept.
Say you have a $120,000 mortgage on a home that’s worth $250,000. You learn that you can refinance into a $180,000 loan instead. This new loan replaces your existing one and gives you $60,000 to use at your discretion.
Note that this strategy differs from a traditional rate-and-term refinance. In that scenario, your new loan balance remains relatively the same as your old one, with the option of rolling closing costs into the loan. But, the primary goal is to lower your interest rate, monthly payment, get rid of mortgage insurance or reduce the length of your loan term (or both).
While there are inherent risks involved when you turn an asset such as your home’s equity into debt, a cashout refinance can be a beneficial move if you qualify for one. Let’s take a look at how you can get there.
How to Qualify for Cashout Refinancing
Before we delve into how to spend the money, let’s review how your lending agency will determine your eligibility for a cashout refinance. In general, there are three criteria you’ll need to meet: credit score, loan-to-value ratio, and debt-to-income ratio.
If you’re seeking a cashout refinance on your primary home, typically you’ll want a credit score above a 620; while their are options below this, you will pay more in fees and interest rate. You can check your score through one of the three main credit reporting agencies by contacting the Lindley Team – we can run all three, or do a “soft” inquiry which will give us a single score without hitting your credit.
The maximum loan-to-value ratio allowed for a cashout refinance on your primary home is typically 80%. That means the outstanding loan balance that results after the refinance can’t exceed 80% of your home’s total value. If you’re refinancing a vacation home or second property, it typically can’t exceed 75% of the total value.
The catch? In addition to your loan itself, the amount also includes any other house-related debt you’ve incurred, including a home equity loan or HELOC.
Using the example above, your new loan on a $250,000 house can’t be higher than $200,000. If your outstanding debt already exceeds that, you’ll be ineligible.
The good news is that there are some workarounds. For instance, if you have a VA loan, you may be able to secure a cashout refinance without these loan-to-value terms, though your loan may be capped depending on your geographical location and property type.
Debt-to-Income Ratio (DTI)
Calculate all the debts you pay each month (or have us do this for you). These can range from your student loans to your credit card bill, in addition to your mortgage payment/proposed mortgage payment.
To find your debt-to-income ratio, add these payments together and divide them by your gross monthly income. Typically you’ll need a DTI of 50% or less to qualify for a cashout refinance.
To verify that you meet all the above criteria, you’ll need to share pertinent financial documents with your lender. These will vary, but often includes your:
- Most recent two year’s tax returns
- Most recent two year’s W-2s
- Most recent month’s pay stubs
How to Use the Cash from Your Refinancing
You’ve put in the legwork and were approved for a cashout refinance. Now, how will you spend it? How should you spend it?
There are plenty of routes to take here, many of which can help improve your current financial situation and even improve the value of your home. Let’s review a few common uses.
Home Repairs and Improvements
Do you have a leaky roof? What about a kitchen that screams 1985? You can use your refinance money to cover home improvements and repairs. This is a smart way to improve your living space and make your property more valuable.
Research shows that 52% of Americans are planning a home upgrade project in the next year or sooner. However, only 25% of them have the cash on hand to kick these projects off.
While replacing a broken door or repairing shingles is one thing, keep in mind that not every home improvement will add value to your home. One example is an outdoor pool, which has a lower ROI than other additions and upgrades.
Do your research to make sure you’re focusing your efforts in the right area. You also don’t want to upgrade your home too far outside the range of the rest of your neighborhood.
Do you have a child who’s about to graduate high school? Or, are you thinking of going back to school yourself?
Either way, tuition can be a daunting hill to climb. A low-interest cashout refinance could be the answer you seek, especially when the alternative is a Direct PLUS federal student loan, which currently carries a 7.08% interest rate.
Of course, the risk with this option is that you’re using your house as collateral. And, you’re still responsible for the loan if the college experience cuts short for any reason. This expense may also come at a time where it makes more sense for you to sock additional money away into a retirement savings fund, so take timing into account.
This is why federal student loans are more often the way to go, as they offer additional protection and a longer payment timeline.
A cashout refinance is secured by your home and treated as a first mortgage. As such, its interest rate will likely be lower than the other forms of debt you’re paying on.
To this end, why not use the money to pay off some of these high-interest loans and save money down the road? Two of the most common kinds include private student loan debt and credit card debt. Eliminating or reducing these loans can help rectify your financial situation.
When you obtain the cashout refinance and use it to pay off those debts, you’ll reduce your future interest charges, though do so with caution.
There are some high-interest debts, such as federal student loans, that include critical protections, such as:
- Deferment and Forbearance
- Income-Driven Repayment
- Loan Forgiveness
When you refinance these loans, you’ll lose those protections. Consider if a lower interest rate is worth the risk.
Investment or Rental Property
One of the hottest and most reliable ways to generate ongoing, passive income is by investing in real estate. Even as the market ebbs and flows, the overall value increases over time.
That’s why it makes sense to use your cashout refinance money to pay for an investment or rental property. Not only is this option more cost-effective than other forms of borrowing, but the long-term investment will produce a cash flow that could help offset the costs of the refinance itself!
As a result, the total interests costs on both properties are lower, and you’ll have a reliable secondary income.
Emergency Business Capital
Are you at the helm of a small business? If so, you know how important it is to have emergency savings on hand to help your company weather a financial setback.
Your cashout refinance can serve this purpose, and the time to act is now. Even if you’re not in the middle of a crisis at the moment, you never know when one could hit. This way, you can ensure that you have access to a steady cash flow and can keep your doors open.
Navigating Your Next Steps
Whether you want to add a master suite to your home or send your oldest to an out-of-state university, the reality is that life can be expensive.
In an age of high-interest loans and complicated lending procedures, a cashout refinance can be a refreshingly simple way to gain access to the money you need.
As you navigate this journey, we’d love to help.
We’re mortgage experts well-versed in the cashout/debt consolidation process. To learn more, fill out this quick form and we’ll be in touch soon!