What Is a Cash Out Refinance?
What is a cast out refinance? There are two types of a refinance loan and both perform the same primary function: replacing an existing mortgage with a new one. A refinance can be a cash out refinance or a rate-and-term refinance. A rate and term refinance is a mortgage that replaces an existing mortgage and changes the rate, the loan term or the type of mortgage.
For example, a couple has a 30 year fixed rate mortgage with a rate of 4.75% and they want to refinance to a 4.00% rate. The newly refinanced loan changes the interest rate and reduces the monthly payment due to the new lower rate on the loan. The new mortgage pays off the old mortgage and typically includes the closing costs into the new loan.
When refinancing a loan term that same couple could refinance from a 30 year loan into a shorter term loan such as a 10, 15, 20 or 25 year term. Shortening the loan term reduces the overall amount of interest paid to the lender although higher monthly payments might be the result. Or, that couple decides to refinance out of their 3/1 hybrid loan and lock in a long term fixed rate.
A cash out refinance can also be used for any of these three motivations yet in addition to paying off the existing mortgage and closing costs the borrowers pull out additional equity in the form of cash. The cash can be used for any purpose including paying off a car loan, student debt or credit card balances.
For example, say a borrower wants to refinance out of a 30 year loan into a 20 year and get a lower rate. The current loan balance is $200,000 and estimated closing costs add up to about $4,000. The borrower also wants to replace the roof on the home while also paying off an outstanding automobile balance of $8,000. The borrower applies for a cash out loan in the amount of $200,000 + $4,000 + $8,000 = $212,000.
The lender orders an appraisal and the value comes in at $400,000 providing more than enough equity to accommodate the request. Most cash out refinance loans ask the maximum amount borrowed be limited to 90% of the current market value of the property although other lenders can ask for higher or lower limits.
Because there are closing costs associated a cash out loan pulling out cash should be a secondary, not a primary motivation. If borrowers simply want to tap into their equity a home equity line of credit might be the better choice although the rate won’t be as competitive as one for a cash out refinance. Further, many times the interest rate for a cash out loan will be higher compared to a rate-and-term refinance.
If you’re thinking of refinancing and you have additional equity, you do have an opportunity to take out additional funds and use those funds for most anything you wish. Talk with a loan officer to explore your options.
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