If you’ve got considerable equity in your home, you’ve got some serious purchasing power. And you may be able to use the wealth you’ve amassed in one home to buy another. If you take advantage of cash-out refinancing. Here’s how.
Your First Home Finances Your Second Home
Whether the next house you purchase is a vacation home or an investment property, you might be able to finance its down payment, or perhaps even the entire home, through cash-out refinancing. And at an interest rate that’s comparable with the rates of mortgages for primary residences.
How does cash-out refinancing work?
You are essentially refinancing your existing home mortgage for more than you currently owe, getting the difference in cash. That way you achieve two things: refinancing your current mortgage at a new rate, and getting money to buy a second home. The repayment clock resets to either a 15-year or 30-year mortgage, whichever you choose — you are basically doing a reset on your current mortgage at a different rate.
Let’s look at a hypothetical cash-out refinancing. Say you owe $100,000 on a mortgage for a home that’s worth $200,000. So you have $100,000 in home equity. You can refinance the home for $150,000 and get $50,000 in cash. It’s as simple as that!
How much cash can you get with cash-out refinancing?
Oftentimes lenders will allow you to take out up to 80% of the equity you have in your home; 20% home equity is the line above which most borrowers don’t have to pay for mortgage insurance. In some cases, such as with VA Loans, homeowners may be able to take out up to 100% of the home’s value with cash-out refinancing.
What are the requirements for cash-out refinancing?
While there is no one single set of requirements for all programs, most guidelines take these qualifications into account:
- DTI. Your debt-to-income ratio probably should not exceed 45% — and remember that your existing mortgage counts as a debt.
- Credit score. You may be able to get cash-out refinancing with a credit score that is as low as 620.
- Longevity. Exceptions aside — inheritance is one — most lenders will want you to have owned the home for a minimum of six months in order to approve conventional cash-out refinancing.
Talk to one of the lending specialists at City Lending to see if the equity in your home could make the dream of buying a second home come true.
With today’s attractive interest rates, now is a good time to refinance. The “when” part is clear. But what about the “why?” Why would you want to refinance your mortgage and what will you use the potential savings for? Let’s consider how your specific financial goals can be achieved through refinancing.
The Simple Goal of Saving Money
So how much can you save? Black Knight, a leader in mortgage data and analytics, says that an estimated six million people with mortgages could each save around $275 per month through refinancing. That’s over $3,000 per year for each homeowner who refinances. To put that amount into perspective, that means that in America, there’s a combined annual savings of close to $20 billion that’s not being realized.
How do you know if you’re a good candidate for refinancing? A chat with your lender would be helpful here, but in broad terms, borrowers who have home equity of 20% or more with credit scores that are 720 and up are well-positioned to seek refinancing. These homeowners, which Black Knight labels as “high-quality” candidates for refinancing, may be able to cut up to 0.75% from the rate they are currently paying on their mortgages. Some could see reductions of 1%.
Let’s look at how that kind of reduction would work in practice with a hypothetical $250,000 mortgage loan over 30 years at 4%. If that mortgage was to get refinanced at 3%, the monthly payments would decrease by $140 a month, with an annual savings of $1,680.
Can I refinance a second mortgage?
Yes. Sometimes called home equity loans, second mortgages can often reap the same refinancing benefits as primary ones. Notably by reducing monthly payments for short-term savings and/or offering long-term savings through paying less interest. Got high payments on a second mortgage? You might consider lengthening the loan’s term to give you some relief on monthly expenditures. Or you may wish to increase the amount of the loan, and just might have the increased borrowing power to do so; the unprecedented rise in home values across America of late has given many homeowners equally unprecedented home equity to tap into.
Could a cash-out refinance be right for you?
Just as it sounds, a cash-out refinance is used to put cash in your hand to use any way you wish. If you want to use the money to buy a diamond-studded hot tub, go right ahead. Though most folks use the money more practically. Data from the Federal Home Loan Mortgage Corporation (Freddie Mac) shows that around 40% of homeowners who do cash-out refinancing use the money to pay off debts, while about 30% of them invest in their homes through repairs or construction. 7% of borrowers use the cash-out money for college, 9% buy cars, and 14% of them put their refinancing savings in the bank.
Home Improvements With FHA 203Ks
As Freddie Mac data shows, home improvements are one of the leading reasons why homeowners turn to refinancing. But cash-out isn’t the only way to go here; FHA 203K Rehabilitation Loans are designed specifically for home improvements, whether it is upgrades, such as bathroom and kitchen makeovers, or significant reconstruction. As they’re backed by the Federal Housing Administration, 203Ks often have fewer requirements and more flexibility with qualification compared to conventional mortgages.
How do FHA 203K Rehabilitation Loans work with refinancing? To answer the first question of many, No, your initial mortgage doesn’t have to be an FHA Loan — anybody can do refinancing using an FHA 203K. And as with other refinancing options, the repayment of the loan can be rolled into your monthly mortgage payments. There are two types of 203K refinancing: limited and standard.
- Limited 203K refinancing, sometimes referred to as streamline loans, has no minimum cost threshold and offers as high as $35,000, with further flexibility in that homeowners can choose their own contractors and, in some cases, even do some of the improvements themselves. If projects come in under $15,000, inspections aren’t required. But you can’t do most major structural work with a Limited 203K. For those, you need a Standard 203K.
- Standard 203K refinancing starts with projects that cost $5,000 and up. No matter the cost of the renovations, all work needs to be inspected by a consultant who is approved by the U.S. Department of Housing and Urban Development (HUD). A few FHA-approved exceptions aside, homeowners must work with general contractors who are licensed. Standard 203K refinancing is usually for big stuff like replacing plumbing systems or adding on extra rooms.
Defining Your Goals
Knowing exactly what you want to do with the extra money you gain through mortgage refinancing is an important part of the process. What are your financial goals? Maybe you’re looking to pay off debt, put away money for retirement, or just make sure you have enough cash on hand to deal with any emergencies that life throws your way. For many, paying off a mortgage is a goal, and so refinancing from a 30-year mortgage down to a 15-year mortgage is a simple way to achieve that objective. Whatever you wish to achieve, you should go into the refinancing process with that singular goal in mind.
Consider Your Closing Costs
The closing costs of refinancing often run between 3% and 6% of the loan’s total amount. Your lender can give you a more precise idea of what the costs of your refinancing will be, and how they factor into the overall cost-benefit analysis you’ll have to make, calculating your break-even point. Say, for example, you refinance with $15,000 in closing costs to give you a monthly savings of $200. It would take 75 months for those savings to cancel out the closing costs and then all savings after those 75 months are the true cash-in-pocket gains.
