Whether you need additional funds for an upcoming large purchase, take money out to invest in real estate, or you just want to get a better interest rate for your home loan, one option you can consider is refinancing.
Actually, I have personally done a cash out refinance on my properties over 12 times now!
Each time I do it, I buy another rental property that makes me $250 or more each month in passive income.
You can read all about how I do that here: The BRRRR Method
Now, what is cash out refinance and how do you do it? Well, it is super easy to do and I'll show you exactly how to do it, the benefits, and everything else about the cash out refinance.
Best Reason for Cash Out Refinance
TAX FREE MONEY! 🙂
Ok, I had to get that out of my system.
Yes, when you do a cash out refinance, you are getting a loan which is not taxed by the government and the IRS.
Because this is a loan, you will not be taxed. Even if you use it to buy a car, remodel your home, go on an awesome world trip, or anything else, the IRS will not tax you on this
A cash out refinance is NOT income in the eyes of the IRS.
Your cash out refinance is considered debt which is not taxable.
I've used my cash out refinance to buy MANY rental properties that make me thousands of dollars every month in passive income.
What is Cash Out Refinance?
Cash out refinance will basically replace the existing mortgage with another loan that has a higher balance.
Sometimes the terms of the new loan are more favorable than those of the existing loan. The homeowner gets the difference in cash.
Cash out refinance is commonly used for:
- Invest in real estate
- Finance a business
- Pay off credit card debt
- Cover college tuition
- Make home improvements
- Manage emergency expenses.
There are three popular options for cash out refinance, and these include:
- FHA Cash Out – This is a cash out refinancing option available to those homeowners who have over 20% home equity.
- Conventional Cash Out – This cash out refinancing option is for qualified homeowners who have over 20% home equity.
- VA Cash Out – This option allows active service members and US veterans to get more equity from their loan.
How Does Cash Out Refinance Work?
A cash out refinance is an excellent way for you to borrow money and refinance your mortgage simultaneously. Your mortgage will be refinanced, and you will get a check during closing.
The balance that you will owe on the new mortgage is going to be higher than that of your old one. It will be based on the amount of the check and other closing costs added to the loan.
The result is that you will increase the mortgage principle that you owe PLUS you will have extra money given to you at the close of the mortgage process.
There are no restrictions when it comes to using the proceeds you get from the cash out refinance.
This means that you can use it for whatever you need but expect that there will still be tax consequences.
Cash out refinance works like the combination of a home equity loan and refinancing.
You will be able to borrow the cash you need, just like with a line of credit or home equity loan.
When Should You Cash Out Refinance?
There are several common reasons for you to choose a cash out refinance.
Below are some of the scenarios when you might want to consider a cash out refinance:
- You want to use the money to invest it into another property to make more money in passive income each month.
- You want to use the equity on your home to pay for some improvements that can increase the overall value of your property.
- You encountered some unexpected expenses like expensive and urgent car repairs or emergency medical bills.
- You want to pay off high balance or high-interest credit cards or get rid of other high-interest debts to save money.
- You need some help to pay for the college education of your child or children.
You want to make the most out of the possible benefit of tax deduction in relation to the interest paid on the mortgage loan.
Just remember that even if you might be in any of the situations above, it is important to think about your decision first to determine if a cash out refinance is the most sensible option for you.
The Rates for Cash Out Refinance
Cash out refinance can be available through an adjustable rate mortgage or a fixed rate mortgage.
Currently, the mortgage rates are around 4%-5% for a cash out refinance loan BUT, that will change with many different reasons.
- Your credit score
- Current market conditions for loans
- Debt to income ratio
- How much you want to pay extra to pay down the debt
Your lender may give you information regarding adjustable rate and fixed rate mortgage options to help you decide on the one that suits you best.
It is also possible to add costs related to getting a new mortgage in the overall refinance amount so that you don’t need to pay anything out of your own pocket during closing.
But cash out refinance may lead to a higher rate or longer term of the loan, and this may mean that you will have to pay more in interest in the long run.
Cash Out Refinance with Bad Credit
There are numerous mortgage options available if you want to get approved for cash out refinance.
If you have good credit, a conventional loan is probably the best choice you have. Now, if you have fair to poor credit, your best option is to go for an FHA loan.
Veterans of the Armed Forces of the United States who are eligible to apply for VA financing can get a cash out refinance to a maximum of 90% of the value of their home even if their credit is below 580.
If you don’t meet the guidelines set by the VA or FHA because you just had a short sale, foreclosure, or bankruptcy recently, your best option is a portfolio loan.
Portfolio loans can be a big help in situations that need common sense and a more unique approach for approval.
A portfolio loan is less strict compared to traditional financing and is meant to be the short-term solution for a short-term circumstance.
Once you meet the traditional guidelines for lending, you will want to cash out refinance the portfolio loan.
Cash Out Refinance vs. Home Equity Loan
A home equity loan is usually a second mortgage. Basically, this is the mortgage you take out aside from the main mortgage you already have on your property.
A home equity loan means a second liens against the house, and this is what makes them riskier.
On the other hand, a cash out refinance is not considered as a second loan but rather a new first mortgage.
What makes cash out refinance and home equity loan different?
- A cash out refinance replaces the first mortgage.
- A home equity loan is a different loan in addition to the first mortgage.
- The borrower will pay the costs of mortgage refinance closing.
- Most of the time, but not always, the interest rates on cash out refinancing are lower compared to the interest rates on home equity loans.
- Closing costs can range from hundreds to thousands of dollars.
- In general, the borrower doesn’t pay the closing costs for home equity loans.
Can You Cash Out Refinance an Investment Property?
Aside from owner-occupied homes, cash out refinancing can also serve as a good option for investment properties, although it might be a bit harder to obtain at times.
After the 2008 housing crisis and the economic downturn that followed, lenders were cautious in refinancing investment properties, especially with a cash out option.
Luckily, things have changed, and once again, cash out refinancing for investment properties has become a viable option for people with enough equity.
Just like in conventional cash out refinancing, everything is dependent on the equity that you got in your investment property.
A greater equity can increase your chances of qualifying for refinancing and taking advantage of the transaction.
The rule is that loan to value limits is capped at 75% for non-owner-occupied properties. There are rare instances when lenders may allow extending the limit to up to 80%, but this depends on the equity of the property and the financial profile of the owner.
However, these loans often come with higher rates of interest and more restrictive terms.
Although investment and rental cash out loans follow many of the guidelines in traditional refinance programs, some rules specifically apply to the refinancing of properties that are not occupied by their owners:
- For a non-owner-occupied property, the loan-to-value limits vary according to the property’s nature itself.
In single-unit properties, there is a maximum 75% LTV while 2 to 4-unit properties have a maximum LTV of 70%.
If the investment property in question was up for sale for the past six months, the cap of the LTV limit would be at 70%.
- An investment property will not be eligible for cash out refinancing if it was bought within the last six months.
There are exceptions to the rule if the said property meets Fannie Mae’s Delayed Financing Guidelines.
- To qualify for refinancing, the investment property shouldn’t be listed for sale during the time of the application.
When used properly, refinancing an investment property is a good way to make the most out of your investments.
But some risks will always be involved, especially when property values decline.
Cash out refinancing for investment properties may be tricky to obtain. One should expect the vetting process to be more meticulous compared to applying for a cash out refinancing for an owner-occupied property.
To qualify for cash out loan on an investment property, it is important to show proof of excellent credit history.
You also need to prepare a complete review of all your assets, income, and existing debts.
Cash Out Refinance vs. HELOC?
Below are the important things you should remember about cash out refinance:
- It lets you lower your existing mortgage interest rate and take advantage of a lower total rate than HELOC or home equity loan.
- You will only have one payment and one loan.
- Your first mortgage will be reset, and this will potentially add more years to its term.
- The loan charges an interest that can be tax deductible.
- You have to borrow all the cash right away and start paying it immediately every month.
- The process of closing can be long, and the costs of closing can reach up to 7% of the overall loan amount. However, you can also go for the no closing cost option that will bundle the closing costs at a higher interest rate.
Meanwhile, HELOC is almost the same as a home equity loan because this is also a type of second mortgage that you secure with the use of your property as the collateral.
But, instead of paying out a lump sum, HELOC is more flexible since it acts as a revolving credit line with an adjustable interest rate.
It also allows you to borrow what you need and when you need it.
There are several basic things you should know about HELOC that makes it different from cash out refinance:
- HELOC is faster and easier to secure because there are fewer lending restrictions.
- The rate of interest is usually lower than that for home equity loans.
- You will only draw the cash whenever you find it necessary, and you don’t have to pay any interest until you need it.
- There is an adjustable interest rate that can rise anytime and result in higher payments due.
Cash Out Refinance Calculator
The equity in your property or home can be used to consolidate other debts or fund other types of expenses.
Cash out refinance can replace your existing mortgage for higher than what you owe at the moment.
But you will get the difference in the form of cash that you can use according to your needs.
A cash out refinance calculator can help you determine if this option is something worth considering and provide you with a good idea of the mortgage rate that you will have after the refinancing.
At the end of the day, a cash out refinance is a sensible option if you will be able to get a favorable interest rate on your new loan, and you also have a sound or immediate use for the cash.
However, it is not a good idea to use a refinance for funding a new car or a grand vacation because you will have little to no return on the money.
Meanwhile, using this money for funding a home renovation may help in rebuilding the equity you are taking out.
You will have a better financial footing if you will use it to consolidate debt.
You must make payments on the new loan in full and on time since you will use your property as collateral for cash out refinance.
Wrapping Up The Cash Out Refinance
Honestly, I have done a cash out refinance MANY times.
Probably around 12 times or so on my various rental properties AND primary residences.
Each time I do a cash out refinance, I am able to buy another rental property that makes me money every month.
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