There comes a time when homeowners need refinancing to fund investment opportunities. While for other homeowners, the refinancing helps them renovate their homes, repay their existing loan, or fund specific projects. Cash-out refinancing is a financing option best suited to finance their needs. Cash-out options involve taking up a new mortgage, of a larger amount, with the aim of converting the new home equity to cash. Cash-out options are an example of private money loans that we at Money Lender Loans offer our Orange County clients, and one you should consider applying for.
Breaking Down Cash-Out Refinancing
Cash-out refinancing, as the name suggests, is receiving cash by taking out a second loan on your property. It is an alternative to a home equity loan. If you bought your house through a mortgage, over time, the mortgage value would decrease due to your monthly repayments. The worth of your home, however, will have increased in the same period. If you take out another loan on your home, a second mortgage of a higher value than the first and use it to pay the outstanding balance on the first mortgage, the difference between the second mortgage and the outstanding amount in your first mortgage is a cash balance. The cash balance referred to as the cash-out amount. The following example elaborates on this concept further.
Your original mortgage value was $300,000. After several years of honoring your repayment plan, the principal declined to $200,000. In the same period, the value of your house increases and is valued at $400,000. Most homeowners seek financing to the tune of 70 to 75 percent of their home’s value. Say you access 75 percent financing against your $400,000 home, $300,000 will be forwarded to you.
$300,000 is considered as your maximum loan amount in this case. After you clear your first mortgage’s deficit of $200,000, you will have a cash sum of $100,000. This action is referred to as cashing out on your home's equity, and $100,000 is the cash-out sum.
The second mortgage comes with its costs and fees, whose value ranges from 3 to 6 percent of the amount in your second mortgage. Such fees and costs are often deducted from the sum you cash out. Additionally, cash-out refinancing options attract higher interest rate charges than conventional mortgages. Further, the terms of your cash-out refinancing agreement may be in effect for a period within 10 to 30 years.
There are three components of importance in cash-out refinancing packages.
- The existing mortgage balance – Your loan balance informs you of the amount you should seek.
- The fair value of your property – The lender will be particularly interested in the value of your home. It helps determine how much they are willing to offer in your Cash-out loan request.
- The new loan amount – This refers to the sum approved by the lender. This sum will be the basis of the new loan terms.
Lenders of Cash-out refinancing finance your application to the tune of 70 to 80 percent of your property’s fair market value (FMV). This consideration by lenders is referred to as a Loan-to-Value (LTV) ratio. Here is an example to help break it down.
For a property with a fair market value of $200,000 with a loan-to-value ratio of 75 percent, the maximum refinancing sum they can access is $150,000. The refinance value is derived from the following formula:
FMV * LTV = The Maximum Refinance Amount
$200,000 * 0.75 = $150,000
The lender offering the Cash-out package pays off the existing loan, and the cash difference is wired to your account.
The Difference in Taking up a Cash-out Mortgage Over a Home Equity Loan
A cash-out mortgage and a home equity loan are financing options available over and above the existing mortgage on your house. Should you take out a home equity loan, you will be making loan repayments over and above your current mortgage payments. Cash-out replaces your existing mortgage terms with the terms under the cash-out arrangement. This is why cash-out refinancing is a favorite among many.
There are three home equity loans available in the market. They are:
- (HELOC), the Home Equity Line of Credit– A revolving credit facility pegged on the value of your home.
- (HEL), the Home Equity Loan– A loan paid back over an agreed time.
- (LOC), the Investment Property Line of Credit– A revolving credit facility offered for a non-owner occupied property.
Taking up a home equity loan over and above your existing mortgage means that you have to part with more sums to repay both loans. On the other hand, cash-out mortgages allow you to clear your first mortgage and be bound by the repayment terms of the second mortgage. Thus, it is cheaper than taking out a cash-out refinancing option as opposed to a home-equity loan package.
Qualifications to Access Cash-out Refinancing
Lenders of cash-out refinancing will need you to meet specific qualifications for you to access the finances.
- You should have a credit score of 640 or above,
- Your property should not be listed at the time of applying for a cash-out refinancing,
- Your debt-to-income ratio should be between 36 percent and 45 percent,
- You should have a 30 to 40 percent equity in the property stated in the application. This is regardless of whether you own the property as your primary residence or whether it is a property you invested in, but another occupies it.
- You should have filled your tax returns within the last two years,
- You should have cash reserves of more than six months,
- Your DSCR (Debt Service Coverage Ratio) should be 1.25. Details of the DSCR will be shown in your current property lease,
- You should have owned the property for not less than six months.
It is important to note that your credit rating affects your debt-to-income ratio as well as your cash reserves. A low credit score means you have a high debt-to-income rate and higher cash reserves. It also follows that with a high credit score, your debt-to-income rate is low as well as your cash reserves. This is the evaluation done by a lender for the owner-occupied property. These very aspects inform the decision to fund no more than 75 percent of your property’s FMV and require that you have a 30 to 40 percent equity.
If your house is an investment property, you can only access cash-out financing to the tune of 70 percent of your property’s FMV. However, the sum can only be paid out if the delayed financing rules are met. They include:
- The loan amount should be less than the purchase price inclusive of the closing costs.
- The purchase transaction should be at arms-length. That is, no previous relationship existed between the buyer and the seller of the property at the time of purchasing the property.
- There should be a final disclosure indicating all details of the transaction.
Types of Cash-out Refinance Packages
Needs influence the choice of the refinance package you choose. These very needs also informed the two types of cash-out financing options available in the market. Private money lenders offer the following types of cash-out refinancing:
With Cash-out refinancing, you are not limited in the use of the funds. There are various reasons you could seek financing, including:
- Home renovation needs – Renovation is a strategic move aimed at improving your house’s market value, thus improving on your equity. Such modifications ensure your property sells at a price that will more than recoup your initial investment in the house.
- Capital needs for a business Venture – Using mortgage funds to finance a business is a risky move. However, many have been able to inject the needed capital in their business venture, a move that paid off in the success of their business. You will need to have a business or an idea that is an assured success. Otherwise, you risk losing your home should it fail.
- Education expenses – Some homeowners have used second mortgages to pay for their educational pursuits. Noble, as the idea is, paying for your education using funds from the cash-out package has to make economic sense because your home is on the line. There has to be a financial assurance after completing your education. Such guarantees come from a promise of a promotion, or increased pay, or a new job with better pay packages upon completing your studies.
Limited Cash-out Refinancing
Limited Cash-out refinancing limits you on the use of the Cash-out funds. You will be required by the lender to offer details of where you plan to channel the funds you seek. Therefore, the lender can approve your loan request or deny it altogether. They need to be satisfied that your use of the funds guarantees that you will pay back the sums in full within the agreed time.
In most cases, lenders offer this loan to replace the existing loan while homeowners opt for the second loan because of favorable loan terms. While you may have several uses for the Cash-out funds, prudence dictates that you use the funds in economic generating activities. Such activities will generate revenue you can use to repay your loan.
Cash-out Refinance and the Tax Implications
Applicants of the cash-out refinance loan enjoy tax-free cash. The cash balances received after repaying the existing mortgage is not subject to taxation because the IRS does not consider this cash sums as earned income. The cash is from your home’s equity, and as such, it is not earned income.
Interest charges on the new loan are tax-deductible as is the case with any mortgage. Therefore, you can write off the costs when filing your tax returns. However, if you have plans to sell off your property, you will have to pay a gains tax on the proceeds of your sale. This is so because the proceeds from the sales are earned income. However, a tax expert should help guide you on the tax legalities to be cautious of.
Value of Cash-out Refinancing
The actual value of cash-out refinancing to a homeowner is only evident in an assessment of the pros and cons of cash-out financing. Here is an evaluation of the advantages and disadvantages of taking up cash-out refinancing.
Advantages of Cash-out Refinancing
Homeowners enjoy some benefits cash-out refinancing provides. They include:
- Pays off High-Interest Loans
While making payments on your mortgage over the years, your loan may prove to be expensive. Cash-out options may offer less costly terms, such as high-interest rates. As such, you have the option of taking up the cash-out loan and pay off your existing mortgage’s balance. You will then have to repay the second loan, which in most cases, is cheaper.
- Get Funds for Your Remodeling Projects
Home remodeling projects are capital intensive. Your savings may not be adequate to complete the project as expected. Home equity and personal loans may prove costly for this undertaking. Further, there is no guarantee that you access these loans. Cash-out loans, on the other hand, offer the funds you need at friendlier rates.
- Helps Organize your Loan Books
Personal loans, credit card debt, and home equity loans are expensive. Repayments may become strenuous due to the cost implication. Further, servicing more than one loan is also not easy. You can consolidate your loan books and only service one loan. Using funds from cash-out loans, you can pay off all your debts and have one loan package, the cash-out loan as the only debt in your books. This helps you ease your repayment burden.
- Improves your Credit Score
Credit ratings are based on your repayment history and the value of the loans you service. Using a cash-out loan to pay off your outstanding debt improves your credit rating. Improvement in your credit history improves your overall life. You can access more substantial loan sums, or pay less on your insurance premiums, among other advantages.
- You Can Access Funds to Invest
You can take out a cash-out package to have funds to channel towards an investment endeavor. The cash balance you get after paying off a debt can offer a reasonable sum for investment. Further, you can also secure a second mortgage to fund an investment opportunity.
- Cash-out Refinancing Offer Large Loans
The sums offered by lenders in these packages are substantial. Personal loans and other loan packages offer significantly lower sums, and that is why cash-out packages are a favorite to many homeowners. The interest rate charges are relatively more economical compared to other loan offerings in the market.
- Potential Tax Benefits
The cash balances you receive after paying off the outstanding loan sums are significant and not subject to taxation. You, therefore, have more money to take care of your needs without having to worry about the added cost of the loan in the form of taxation. You further get to enjoy tax deductions on the cash-out refinance package when filing your annual tax returns.
Disadvantages of Cash-out Refinancing
The financing option has its fair share of shortcomings. They include the following.
- Your Home is the Security for the Loan
One downside of taking a cash-out refinancing package is that you risk losing your home should you default on your loan repayment. The lender may be lenient if you run into some financial hurdles and accept to extend your loan over a couple of months. However, they can only extend such leniency for so long.
- You Risk Losing your Home’s Equity
Outstanding loans affect the equity in your home. Your home’s equity is determined by considering the unsettled loan against its fair market value. Lenders use this term to determine how much they can extend to you as a loan. In most cases, taking up a loan such as cash-out refinancing puts you at risk of affecting your home’s equity.
For example, in the event, you have an outstanding credit whose value is higher than its fair market value, your home is said to have negative equity. The negative equity thus negatively impacts your investment portfolio.
- You Increase Your Mortgage Payment
You may use the cash-out loans to reduce your loan balance or reorganize your loan books. What does not change is that by taking up a cash-out facility, you have a new loan and new terms. Some of the conditions include new repayment periods that extend your repayment period. Therefore, you will end up spending more time servicing your debt.
Finding a Lender Near Me
Cash-out financing allows an investor to access funds from their equity to take advantage of investment opportunities. Further, you can use the sums to improve your home, pay a down payment on a new property or a property set for construction. Therefore, you are not locked out of investment opportunities or renovation needs thanks to cash-out refinance. You can access this mortgage and other credit facilities from Money Lender Loans. Get in touch with us at 949-409-4372 and let us help you choose a refinancing package that suits your needs.