November 1st, 2019 8:33 AM by Jackie A. Graves
In the real estate
world, refinancing is
the process of replacing an existing mortgage with a new one that typically
extends more favorable terms to the borrower. By refinancing, the borrower may
be able to decrease their monthly mortgage payments, negotiate a lower interest
rate, renegotiate the number of years—or term—of the loan, remove other
borrowers from the loan obligation, or access cash through home equity that has
built up over time. A cash-out refinance is a mortgage refinancing option in
which the new mortgage is
for a larger amount than the existing loan amount in order to convert home
equity into cash.
The most basic
mortgage loan refinance is the rate-and-term.
With this type, the borrower is attempting to attain a lower interest rate
and/or adjust the term of the loan. For example, if a property was purchased
years ago when rates were higher, the borrower might find it advantageous to
refinance in order to take advantage of lower interest rates that now exist.
Also, variables may have changed in a borrower's life so that they could now
handle a 15-year
mortgage (saving massively on interest payments), even though
it means giving up the lower monthly payments of their current 30-year
refinance has a different goal. It allows borrowers to convert home
equity into cash by creating a new mortgage for a larger amount
than what is currently owed. The borrower receives the difference between the
two loans in cash. This is possible because the borrower only owes the lending
institution what is left on the original mortgage amount. The additional loan
amount of the refinanced, cash-out mortgage is paid to the borrower in cash at closing.
Compared to rate-and-term, cash-out loans generally come with higher
interest rates or other costs, such as points. Lenders are worried
that borrowers who have already taken out substantial equity might be more
likely to walk out on their new loan, although a high credit score and low loan-to-value
ratio (LTV) can allay those concerns and help the borrower get
a favorable deal.
A homeowner took out
a $200,000 mortgage to buy a property and, after many years, still owes
$100,000. This means that the owner has built up at least $100,000 in home
equity (assuming the property value has not dropped below $200,000). To convert
a portion of that equity into cash, the owner could opt for a cash-out
The maximum amount of cash available to an owner in a cash-out
refinance depends on the property's loan-to-value ratio.
If they wanted to convert $50,000 of their equity, they could
refinance by taking out a new loan for a total of $150,000. The new mortgage
would consist of the $100,000 remaining balance from the original loan plus the
desired $50,000 that could be taken out in cash. In other words, they can
assume a $150,000 new mortgage, pay back the $100,000 owed on the first
mortgage and have $50,000 remaining.
By calculating the
property's present loan-to-value ratio (LTV), a lender can establish
a maximum loan amount for a cash-out refinance. The lender looks at the
value of the property in comparison with the outstanding
balance the borrower owes on the existing loan.
If we use the previous example—and assume that the current
market value of the property is $250,000—and that the lender has set a maximum
LTV of 80%, the maximum cash-out refinance amount would be $100,000. The 80%
LTV would establish that the maximum amount of the new loan would be $200,000,
or $250,000 x .80. After the initial mortgage is paid off ($100,000), there
would be $100,000 in cash available to the borrower.
If you’re looking to refinance a home loan, don’t let a
drawn-out process slow you down. Better has streamlined
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