Can increasing home prices lead to cash-out refinance?

Posted by  on Nov 02, 2012

Cash-out refinancing, when homeowners refinance their property and increase the size of their mortgage, were extremely popular during the high-rolling housing market when values were rising fast. As home values plummeted, fewer homeowners took cash out when refinancing simply because they often didn't have enough home equity to borrow against. In the second quarter of 2012, Freddie Mac reported that just 19 percent of all mortgage refinance loans were larger than the existing mortgage.

Recent trends offer a glimmer of hope

Recent housing market reports suggest that home values are returning in many markets. In fact, in October 2012, the National Association of Realtors said that prices on existing homes rose by 11.3 percent from September 2011 to September 2012.

While current mortgage rates make cash-out refinancing appealing, homeowners need to consider both the benefits and disadvantages of this type of refinancing and determine whether they qualify for a cash-out refinance.

Qualifying for a cash-out refinance

The first qualification you'll need for a cash-out refinance is the home equity to allow you to refinance, take out the cash you want, and still have a maximum loan-to-value of 95 percent. Many lenders will only allow a cash-out refinance on a loan-to-value of 80 percent. You can consult a realtor to estimate your home's value, but a lender will require an appraisal.

Remember, if your loan-to-value is less than 80 percent, you'll need to pay private mortgage insurance (PMI), which adds to the cost of the loan.

In addition to your home equity, you'll need to meet debt-to-income-ratio requirements on the higher mortgage payments. Most lenders will allow a maximum of 45 percent debt-to-income, but many will require a lower ratio, particularly on a cash-out refinance that could be considered a risky loan.

Finally, you'll need a credit score of at least 740 to receive the lowest mortgage rates. Typically a lender will require a minimum credit score of 640 or above even to consider you for a mortgage refinance.

Cash-out refinancing benefits

If you are using a cash-out refinance to pay off credit card debt, you can usually reduce your interest rate significantly and garner the tax advantage of deducting the interest payments on your home equity loan. Your monthly payments are likely to be much lower than when you were paying credit card companies.

If you are using your home equity for other reasons, be sure to compare your other options for financing a home improvement or a tuition payment.

Disadvantages to cash-out refinancing

While all home refinance options incur closing costs, a cash-out refinance typically carries a higher cost than other types of refinancing. You may want to consider a home equity loan instead, which has very low costs.

Besides the costs of a cash-out refinance, the other major disadvantage is that you are reducing your home's equity. If home values decline again, you could end up underwater on your mortgage. In any case, you are reducing the profit available when you sell your home.

Consider carefully the pros and cons of a cash-out refinance before you choose this solution to your cash needs.

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