Understanding The Cash-Out Refinance


What is a Cash-Out refinance?

A cash-out refinance enables homeowner to remortgage their home for an amount greater than the exiting mortgage balance. Once the new mortgage is approved and a mortgage closing takes place, the homeowner then begins to make repayments on the new higher amount over the course of a new term. In other words, this cash-out refinance results in a brand new mortgage for the homeowner with new interest rate, new term and new payments. So the reason for refinancing should be a good one and the reason for taking cash-out should be as good or better.

When is a Cash-Out Refinance possible?

A homeowner can apply and, most likely get an approval for a cash-out refinance when there is enough existing equity in the home (for a FHA refi, at least 85% of the property’s appraised value must cover the existing mortgage, closing costs and the amount of any check written to the homeowner. For a conventional refi it’s 80%). This is important because the lender is able to justify the approval of increased funds to the homeowner due to the value of the property. Every lender must have security and collateral for every mortgage, and the cash-out refinance is no different.

Homeowners who wish to take advantage of a cash-out refinance offered by a lender should inquire as to whether or not the lender offers this type of refinancing. This is important because not all lenders offer this option. It should actually be one of the first questions the homeowner asks when inquiring about refinance programs. Doing so will save homeowners, who are seeking a cash-out refinance, a great deal of time.

How Can the Cash be Used?

For many homeowners the most appealing aspect of cash-out re-financing is that the additional funds can be used for any reasonable project or undertaking the homeowner wishes to accomplish. The lender will require an explanation (most likely in affidavit form for FHA mortgages) of how the cash-out money will be used.

It has to make sense to the lender and must also be in accordance with refinance mortgage guidelines set by both conventional and the FHA. Most homeowners would probably not refinance their homes and use the cash to gamble in las vegas or Atlantic City, but in the circumstance where there is one or two who might need cash-out refinance funds to gamble with, they would have to look elsewhere because they wouldn’t get it from a mortgage lender.

That having been said, most homeowners I’ve dealt with during my years as a mortgage lender representative had very practical reasons for wanting a cash-out refinance, and in my opinion that hasn’t changed with homeowners wanting to refinance today.

Of course, getting approved for a cash-out refinance is more of a challenge for today’s homeowners due to the loss of equity and underwater mortgages many have suffered as a result of the subprime mortgage crises. Those who have enough equity for cash-out refinancing will be wise to use the funds in a judicious manner. Some of the popular uses for funds received from cash-out refinancing include:

  • Home Improvement Projects
  • Home Renovations
  • Child’s College Education
  • Hospital/Health-related Bills
  • Mortgage Debt Consolidation
  • Credit Debt Consolidation

There are probably a few more, but all the reasons listed above are excellent uses of a cash-out refinance that a lender would certainly approve your cash-out refinance for. Homeowners who are considering this type of a refinancing option should also consider whether or not the closing costs and other expenses related to the loan are tax deductible.

Using the cash-out option to make home improvements is jus one example of a situation where the funds can be tax deductible. Homeowners should consult their tax professional on the matter to determine whether or not they are able to deduct the interest from the repayment of their refinance mortgage.

An Example of a cash-out Refinance

The process of a cash-out refinance is fairly simple to explain. Consider a homeowner who purchases a home and borrows $150,000 at a rate 7% interest to complete the purchase. Now consider the homeowner has already repaid $50000 of the loan and would like to borrow an additional $20,000 to make a rather large purchase or pay off some credit cards. With this additional funding available the homeowner has an opportunity to use the equity in their home to reduce credit card debt thereby increasing their monthly cash-flow.


In the example above the homeowner may refinance for a total of $120,000 at a lower interest rate such as 6.25%. This process allow the homeowner to take advantage of the existing equity in their home and also allows him/her to qualify for a substantial loan at a great rate AND get rid of credit card debt.

The Question of “How Much”? In Real Estate Investments


If you are considering real estate investments as a part-time business, a full-time career, or a means of raking in some extra cash during your retirement years, one of the first questions you must have an answer to is…How Much? How much do I want, or can afford to invest? How much of a return do I want to get back on my investment? How much work/time am I willing to personally contribute to my new venture?

The answer to your first “how much” question may be the easiest one of the 3 to answer, based simply on your cash-flow position. However, it still requires a good deal of thought and planning on your part, because even if your financial position is very strong, you still need to work with an investment budget that will be used specifically for your first real estate investment as well as future investments. Obviously you’re not going to just throw money at any of your projects.

If you haven’t constructed a sensible and comprehensive plan then the answer to the second “how much” question will be quite an easy one, but not necessarily a sensible one. “As much as I can get” is hardly an answer given by a prudent (if not astute) investor when asked what kind of ROI do you anticipate? No, you must think in terms of percentages, albeit a wide range of percentages, but nevertheless percentages. This answer will have more to do with how you answer the third question than the second question, because the higher of an ROI you want to get, the more of your personal time/work you may need to contribute.

Let’s look at it this way. If, for example, you have the knowledge, experience and expertise to manage most aspects of your real estate investments, and you have the cash resources to make purchases without the need for financing, you automatically eliminate at least 3 real estate specialists that would otherwise have to be a part of your investment team, so to speak. In doing so you eliminate any fees, commissions or charges that would have been paid to those specialists thereby increasing your ROI.

Investment in real estate of any kind doesn’t mean just handing over an extra amount cash. With every large investment, there are specific rules and processes that are defined in order to ensure that your money will be going to the right place. If you are investing in real estate, you will want to know what initial investments will be as was mentioned as the first “how much” question.

If you have found a property and are beginning a process for buying that property, you will begin to make some initial investments soon after the first contract is signed. Most real estate purchases will require a down payment, which usually consists of money going to the person that is selling the property. This will then be credited towards the purchase you are making. If you have extra money set aside, you may want to include it in the down payment, as this will make a difference in the amount you’ll have to finance, your final approval AND the amount of your monthly repayments.

Another set of investments that you will be making is for any extra costs from the team that you have put together. For example, a property inspection will usually cost a small amount of money. There may also be extra fees linked to the lenders paperwork and other expenses you may incur relative to the contract. Every person that is working with you will receive a commission or part of the investment that you are making in the beginning.

Before you start out in search of viable real estate investments, make sure that you know about the initial out-of-pocket costs and how it will affect your bank account. Setting aside a specific amount of money for your first property, or knowing how much to include in a down payment after buying a second property will help you to make the right decisions from the beginning. You will also want to make sure that you walk into your investment property with enough money to get you completely in the door and ready for the next phase; Preparing your new investment for resale or tenancy.


When Is Refinancing Into A New Mortgage Not Advisable?


Many homeowners make the mistake of thinking that refinancing is always a viable option. However, there are times when refinancing into a new mortgage is really not advisable. Homeowners can make a significant financial mistake by refinancing at an inopportune time. There is a couple of classic examples of when refinancing is a mistake.

One occurs when the homeowner does not stay in the property long enough to recoup the cost of refinancing into a new mortgage. The other is when the homeowner has had a credit score dropped since the original mortgage loan. Other examples are when the interest rate has not dropped enough to offset the closing costs associated with the refinance mortgage.

Recouping the closing costs

In determining whether or not it is worthwhile take out a refinance mortgage, you should determine how long you’ll have to maintain ownership of the property in order to recoup the closing costs. This is significant especially in the case of you intending to sell your property in the near future. There are refinancing calculators readily available on the Web which will provide the amount of time you will have to retain the property for making a determination whether it’s worthwhile to get a refinance mortgage.

These calculators require you to input information such as the balance of your existing mortgage, the existing interest rate and the new interest rate, after which the calculator returns results comparing the monthly payments on the old mortgage and the new mortgage as well as information about the amount of time required for you to recoup the closing costs associated with refinancing into a new mortgage.

When credit scores drop

If you believe that a drop in interest rates is a signal for you to immediately refinance into a new lower rate mortgage, you may need to take a step back and examine the circumstance. If the new lower interest rates are combined with a drop in your credit score, the resulting refinanced mortgage may not be favorable to you simply because your current credit scores may not be favorably compared to the credit scores at the time of your original mortgage, then refinancing into the new mortgage may not be to your benefit. However, depending on the amount interest rates have dropped, you will have to take out the calculator again to help you make a good decision.

Have the interest rates dropped enough?

A common mistake many homeowners make in regard to refinancing into a new mortgage is to refinance whenever there is a significant drop in interest rates. This can be a mistake because the homeowner must first carefully evaluate whether or not the interest rate has dropped enough to result in an overall cost savings. Homeowners often make this mistake because they fail to consider the closing costs associated with refinancing the home.

These costs may include application fees, origination fees, appraisal fees and a variety of other closing fees and charges. These costs can add up quite quickly and may eat into the savings generated by the lower interest rate. In some cases the closing costs may even exceed the savings resulting from lower interest rates, so it requires careful thought about refinancing into a new mortgage even when there’s a significant decline in interest rates.

Refinancing into a new mortgage can be beneficial even when it is a “mistake”

In reality, refinancing into a new mortgage is not always advisable, but some homeowners may still opt to refinance even when it’s technically a mistake to do so. This classic example of benefitting under adverse conditions is when a homeowner refinances to gain the benefit of lower interest rates even though s/he winds up paying more in the long term. Under these circumstances, the lower interest rate is not low enough to result in an overall savings, but the homeowner benefits anyway because s/he consolidates a considerable amount of short term debt into a long term refinance mortgage.

Although most financial advisors may warn against this type of financial approach to refinancing into a new mortgage, homeowners sometimes go against conventional wisdom to make a change which may increase their monthly cash flow by reducing their overall debt obligation payments. In this situation the homeowner is making the best possible decision for his/her personal needs.