Achieve Your Goals More Quickly by Applying for a Refinancing Option
Cash-out refinancing or cash-out refi is the act of taking out a higher-value loan to pay off an existing mortgage and fees. Some cash is left over to use for other purposes. The extra funds can pay off additional expenses such as high-interest debts, completing home renovations or other large payments such as unexpected medical bills.
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Most people choose one of these three popular cash-out refinance options:
- FHA cash-out
- VA cash-out
- Conventional cash-out
Conventional cash-out and FHA cash-out are available to people with more than 20 percent equity in their homes. VA cash-out options are available to U.S. servicemen and women and veterans. This scheme allows you to take out more funds than your available equity on your property.
Whichever cash-out refi option you choose, it’s essential to understand to process and the facts before you go ahead with your plans. A lump sum may sound like the best move, but it may not be the best option for you at the time. This guide will help you understand your choices, the criteria for refinancing, and alternatives if you decide it isn’t for you.
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Mortgage jargon can be confusing. From adjustable-rate mortgage to fixed-rate mortgage there are so many acronyms and terms to know that it can be challenging to remain confident in your decision. Here’s our handy glossary with some of the most common words.
FHA Cash-Out Refinancing
FHA refi cash-outs are loans that are insured by the Federal Housing Administration. The good news about these types of refinancing loans is if you have a lower income or a lower credit rating, you are more likely to be accepted.
FHA guidelines suggest a credit score of 580+ to qualify, although some insured lenders expect a higher credit score of around 600. You are also likely to have a debt-to-income ratio of 43 percent or less.
VA Cash-Out Refinancing
This refi option is for veterans and active service members and their families. A VA cash-out refi can be used by those who currently have a VA loan or conventional loan. Your credit score is expected to be 620+, and you must intend to live in the property after you have refinanced. Something which isn’t included with a VA cash-out refinance loan is the closing costs. It is vital to factor closing costs when deciding if this is the right option for you.
Conventional Cash-Out Refinancing
A conventional cash-out refi is probably the most popular option. It can be used to borrow up to 80 percent of the current market value of your home. You must pay off existing mortgages or home equity lines of credit. There are strict rules to qualify for a conventional refi. They state you must have owned the home for at least six months, and the home cannot be up for sale.
The mortgage lender assesses the lending risk. To calculate the loan-to-value ratio, you work out the amount of the mortgage divided by the value of the property. The higher the LTV, the greater the risk to the lender. Thus, you’ll often find that those monthly repayments are higher due to a higher interest rate.
What to Consider Before Taking a Cash-Out Refinance
Cash-out refi seems a great option to many who need a large lump sum available without the need to take out additional high-interest loans or credit cards. If you’re considering renovating your home or must pay for college, your goals are perfect for cash-out refinance. However, if you want to pay for a luxury holiday or a brand-new vehicle, it’s probably not the best option. By refinancing your existing home loan with further money on top, you are creating more substantial debt over an extended period. It makes sense to get your finances straight and decide if you can justify this change.
In addition to your personal financial goals, there are other factors to consider, which could affect your application.
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How Much Money do I Need?
The amount of cash you require is the first question you should ask yourself. If you don’t need a considerable amount of money and aren’t planning to use it for a large purchase, you’re probably better off avoiding refinancing. Another critical thing to consider is if the amount you require is more than the amount you can borrow on top of your mortgage repayment. We explain this further below.
Is Your FHA Loan Eligible for Refinancing?
Most FHA loans are eligible for an FHA cash-out refinance loan, but it is always best to check the fine print in your contract. Another option could be a conventional cash-out re-fi, which may seem more attractive if you don’t want the added cost of mortgage insurance.
Are You Able to Qualify for Any VA Refi Options?
Active service-members or veterans who haven’t taken out a VA mortgage before may still be able to apply for a VA cash-out re-fi. Current VA mortgaged properties can also benefit from better rates and a higher borrowing amount. It is worth researching VA cash-out refinancing before considering FHA and conventional cash-out re-fi for the savings you can make throughout your refinance period.
How Many Years Do I Have Left on My Current Mortgage?
The amount of years remaining on your current mortgage is an essential question to ask yourself. If your refinancing options mean you are required to take a new 30-year term, but you only have 20 years left to pay, is it worth it?
What Will the New Monthly Payment Be?
Due to the nature of cash-out refinancing, you are increasing the amount you initially borrowed for your mortgage by adding on the amount you wish to cash-out. This will most certainly increase your monthly payments. If you are using the extra cash to pay off debts, you can save money each month thanks to the lower interest rates you will be paying. Remember not to continue to spend on credit cards or take out any additional high-interest loans. In this case, it can be a good thing. On the other hand, if you are using the funds for home improvements or college fees, there may not be many advantages. In which case, you should seriously consider your expenses and adjust your budget accordingly.
Is There Enough Equity in My Home?
Equity is the difference between the value of the property and the amount you have left to pay off on your mortgage. For example, if your home’s value is $200,000 and you have a $150,000 mortgage, you have $50,000 worth of equity. On average, the maximum loan-to-value (LTV) ratio for conventional or FHA cash-out refinancing is 80 percent. A VA cash-out refi is slightly more, thanks to its beneficial terms. You can get up to 85 percent LTV, although this is likely to change thanks to the latest criteria update. The LTV may drop to 80 percent to create less risk. LTV rates have many factors, including if you occupy your property yourself or rent it out. Other factors include your credit score and the refi option you choose.
Is it Worth Paying More and Starting a New Mortgage Term?
When you take out a cash-out refi option, you will likely be increasing the length of your mortgage term. Some mortgages offer you the chance to choose the length but remember that the monthly payments will increase thanks to your higher loan amount.
Deciding to Apply for a Cash-Out Refinancing Option
If you’ve read through our questions and have decided that a cash-out refi is the best option for you, this section explains the application process.
The Importance of a Good Credit Score
Like applying for your first mortgage, a cash-out refi requires a good credit rating. As explained in our initial definitions of the available types of re-fi options, an FHA cash-out refi can accept people with a lower credit score. You want to make sure your score is 640 or above to achieve the best possible interest rates.
When you apply for your cash-out refi, you must be confident that you haven’t missed any mortgage payments within that last 12 months. You may be able to get away with one missed payment as long it was paid within 30 days of the original deadline. Otherwise, you will probably be declined (which will affect your credit score further!).
If you attend a mortgage advice meeting, your credit rating isn’t that great. You may be able to talk to the lender to influence the decision in your favor. To help the decision, keep track of how you have overcome your poor credit rating and how it has improved. If it looks likely to continue to rise, this may work in your favor for acceptance.
Pay Attention to Interest Rates
A lot of first-time homebuyers are forced to take out mortgages with high-interest rates. If you are one of them, cash-out loans can be a way to reduce the amount of interest you pay. By choosing a loan with a reduced interest rate, you could still stand to reduce the amount you owe. You could also save on the amount you pay back each month even when taking out a cash payment on top. Interest rates fluctuate all the time, so keep up to date with the latest refinance rates to make sure you’re getting the best deal.
ARM vs. Fixed Mortgage Rates
When considering a refinance option and checking the latest refinance rates, you will often see an up-to-date table with various terms and rates. For example, you can view this information on Bank of America’s website. Refinance loans come in two types: fixed and ARM.
Fixed-rate mortgages have an interest rate which remains fixed for the length of the loan term. If you choose this option and interest rates fall, you could end up paying more back than you want to, so think carefully before making a decision.
ARM mortgages are adjustable-rate mortgages; they are often called variable-rate mortgages too. The interest rates on these loans change throughout the life of the loan in line with indexes. The most common indexes used by U.S. banks are the U.S. Prime Rate and the London Interbank Offered Rate (LIBOR). Because the interest rate changes, your monthly payments will go up and down. A lot of people may find this too confusing or have no preparation for a sudden increase in payments each month. ARM mortgages often have a cap that prevents the rate from increasing too much. Thus, you should make sure you work out what this cap is as it can vary between mortgage providers.
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Refinance Rates Differ by State and Type
Not only do your credit score, loan type, and fees affect the price of a cash-out refi, the area where you live also plays a part. A lender isn’t likely to favor one state over another, but it does come down to the state’s economic wellbeing at the time. Thankfully, rate-setters consider the national rates first, but it is worth noting that in some states, taxes, and fees can cause the cost of refinancing to rise. Always seek advice from a local mortgage adviser, and keep your knowledge of local housing prices up to date.
Alternatives to Cash-Out Refinancing
If you don’t match the criteria for a cash-out refinance option or feel that it isn’t an option for you right now, don’t despair. There are other options you can take, and we’ve put together a few choices:
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Home Equity Line of Credit (HELOC)
If you think you don’t need such a large lump sum, a HELOC is a better option. Not only are they faster to close, but their fees are also less costly. HELOCs do not have any limits for their usage. Thus, if you want to pay off an expensive purchase such as a credit card bill or improve your home, this could be another option for you.
A personal loan is an excellent option if you don’t want to start again with a huge mortgage term of 30 years. Personal loans take less time to be approved and may require a lower credit score, depending on your affordability criteria and current circumstances. Some loans release funds within 24 hours, and with a shorter term (generally within the region of five to 10 years) you’ll pay less back overall.
Also, by adding another source of credit to your file, you can be seen as more trustworthy, which can increase your credit rating over time. Just be sure you can keep up with your repayments each month as a default can seriously damage your score. A lower credit rating and any credit defaults also affect any prospects of cash-out refi or similar.
Adding a Second Mortgage
Although you will be paying two mortgages, adding a second mortgage may be a better option. This may be the case even if you can get a better deal with a cash-out refinance loan. Taking out a second mortgage can be less expensive because there may be lower fees and the term will be shorter.
In a Nutshell
Cash-out refinancing is an attractive choice for anyone who wishes to receive a lump sum to pay for other expensive life events. Do not consider cash-out refi for short-term debts like vacation expenses or the purchase of a new vehicle. With the attraction of a lower interest rate, consolidating existing debts and the prospect of higher tax deductions, if you’re able to utilize this option, it is worth applying.
Before you apply, consider any future financial circumstances which may affect your household. We know you don’t have a crystal ball. However, thinking about the future health of the household, career prospects, and the likeliness of any large payments is essential. Making sure you can continuously make payments is important. If you miss a payment, it can seriously affect your future credit options, and you risk losing your home.
On approval of a cash-out refi, the lender will add closing costs. Make sure you factor in these expected costs. If you don’t have the funds currently available, you will need to make sure it is worth paying these fees with the lump sum you have received.
If you want to discuss the option of a cash-out refinance, we recommend speaking to your mortgage provider or financial adviser for impartial advice. Their knowledge and expertise can make the difference between the best choice for your finances and a bad decision that affects you long term.
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