September 14th, 2017 6:37 AM by Jackie A. Graves, President
Mortgage terminology got you down? Don't fret: Figuring out all of
the complicated phrases and vocabulary like "amortization" and "loan to value" is enough to
intimidate any borrower. And, if you’re thinking of refinancing your mortgage,
prepare to learn some new terms: "cash-out loan" and a
"rate/term refinance." Let us introduce you.
think of refinancing as the replacement of an existing mortgage with another,
or the consolidating a pair of mortgages into a single loan. (For more on the
latter, See Should I Combine Two Mortgages
Into One?) Out with the old (mortgage) and in with the
new, as they say. Once you refinance, your old loan is paid off, and a new one
is put in its place.
are plenty of reasons to consider refinancing. Saving money is the obvious one.
In August 2008, the average 30-year fixed mortgage had an interest rate of
6.52%. After the financial crisis, rates for the same sort of mortgage were
practically slashed in half. With a potential
savings of, say, $500 per month on a $250,000 home, refinancing made sense for
a lot of people. This resulted in a wave of refinances that still continues
now, several years later. Even a one-point difference in your rate could
represent a $150 reduction in your payment. (For more on this subject, see: Should You Refinance Your Mortgage
When Interest Rates Drop?)
Refinancing can also offer a chance to convert your adjustable-rate mortgage into a fixed-rate one, to
lock in lower-interest payments, especially if rates seem poised to move
are two basic refinance loans. The simplest and most straightforward is the rate/term refinance (refi).
No actual money changes hands in this case, outside of the fees associated with
the loan. The size of the mortgage remains the same; you simply trade your
current mortgage terms for newer (presumably better) terms. In contrast, in a cash-out loan, aka
cash-out refinance, the new mortgage is bigger than the old one. Along with new
loan terms, you’re also being advanced money—effectively taking equity out of
your home, in the form of cash or to pay off other debts.
can qualify for a rate/term refi with a higher loan-to-value ratio. (It’s easier to get the loan, in other
words, even if you're a poorer credit risk.) Cash-out loans come with tougher
terms. If you want some of the equity you’ve built up in your home back in the
form of cash, it’s probably going to cost you – how much depends on how much
equity you have built up in your home and your credit score.
example, if a borrower's FICO score is 700, the loan-to-value ratio is 76%, and
the loan is considered cash-out, the lender might add 0.750 points to the
up-front cost of the loan. (Each lender is different.) If the loan amount were
$200,000, for example, the lender would add $1,500 to the cost. Alternatively,
the borrower could pay a higher interest rate – 0.125% to 0.250% more,
depending on market conditions.
Why the tougher terms? Because
cash-out loans carry a higher risk to the lender, according to Casey Fleming,
mortgage advisor, C2 Financial Corporation and author of “The Loan Guide: How
to Get the Best Possible Mortgage.” “Statistically a borrower is much more
likely to walk away from a home if he gets in trouble if he has already pulled
equity out of it. It is particularly true if he has pulled out more than he
initially invested in the down payment. Consequently, any loan that is
considered cash-out is priced higher to reflect that risk, until there is so
much equity that the borrower isn't likely to walk away anymore.”
a higher credit score and lower loan-to-value ratio can shift the numbers
substantially in your favor. For example, a borrower with a credit score of 750
and loan-to-value ratio of less than 60% won’t pay any additional cost for a
cash-out loan because he or she is no more likely to default on the loan than
if he or she were doing a rate/term refi.
loan may be a cash-out loan even if you don’t receive cash back. If you’re
paying off credit cards, auto loans or anything else that wasn’t originally
part of your mortgage, the lender probably considers it a cash-out loan. If
you’re consolidating two mortgages into one, and one was originally a cash-out
loan, the new consolidated loan will also be cash-out.
many personal finance experts would advise against stripping your home of its
equity in a cash-out refinance, recent data from Freddie Mac shows that
Americans are choosing this loan type at rates not seen since the financial
half of borrowers chose the cash-out option in the first quarter of 2017 – well
below the 90% level reached just prior to the financial crisis but sharply
higher than 2012 when levels fell to 12%. Why the increase? Not only do
mortgage rates remain low despite the rising interest rate environment, home
prices in many areas of the country have increased to the point where
homeowners have enough equity to make a cash-out refinance worth the expense.
Those higher loan-to-value ratios, and Americans' improving personal balance
sheets, make it easier to qualify.
the help of your mortgage broker, you may be to generate a little cash from
your refinancing without it being considered a cash-out loan (and generating
the extra fees that come with it). Basically, it works by taking advantage of
the overlap of funds at the end of one loan and the beginning of another.
Here’s how Fleming describes it:
are allowed to finance closing costs in a rate/term refi. Most lenders allow
those closing costs to include pre-paid expenses, such as pre-paid interest,
the unpaid accrued interest on your existing mortgage, the money necessary to
pre-fund your escrow account and even property taxes and insurance if you time
you refinance, you pay the accrued interest on your existing mortgage up to the
day it is paid off. You pre-pay your interest on your new loan from the day you
fund until the first of the next month, and then you don't make a payment the
next month. Therefore, you have financed one month's interest on your mortgage
within the new loan.
you have an impound (or escrow) account to pay insurance and taxes with your existing
mortgage, then your existing lender is holding some of your money – at least a
couple of months of taxes and insurance each. When you refinance, your new
lender will need some money on hand when your tax and insurance bills come due
so that they will ask for some money up front. You can usually finance this.
after your loan closes your old lender – who is holding some of your money –
sends you a check equal to the balance of your escrow account when you paid off
that loan. Cash!
because some of the fees change a little up until funding, most lenders allow a
little bit of cushion – up to $2,000 in cash back in escrow without the loan
being considered cash-out.
all this means is that you can finance 'costs' that aren't really the cost of
originating the loan, but rather represent the cost of having the loan. On a
$200,000 rate/term loan, it would be very feasible to generate about $4,000 in
cash – the right circumstances, if it were structured carefully – without
paying a cash-out penalty.”
job as the borrower is to have enough knowledge to discuss options with your
lender. For most people, avoiding the added cost of a cash-out loan is the best
financial move. If you have a specific reason for taking cash out of your home,
a cash-out loan may be valuable, but remember that the extra amount of money
you will pay in interest over the life of the loan can make it a bad idea.
By Tim Parker - To view the original article click here