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There are good and bad ways to use the proceeds from a cash-out refinance. Ideal investments include home improvement and debt consolidation. Ill-advised uses include auto purchases and loans to relatives.
One of the most valuable assets in the typical financial portfolio, home equity, is the least understood. In fact, it represents all kinds of potential for WA state homeowners.
Essentially, equity equals ownership, i.e. that percentage of the property owned outright as opposed to financed by a mortgage lender. Equity is originally established with a down payment at the time of purchase — most of the time — and built upon as borrowers pay down mortgage loan principal and when property value increases. Over time, that ownership portion grows large enough to borrow against.
Financial consultants generally advise against cash-out deals to buy new cars, for example. Other bad reasons include aiding struggling relatives and paying for a vacation. These things do not add — but subtract — value. A car begins depreciating once outside the dealership while a vacation — as refreshing as it may be — is an unquestionable loss financially.
The power of the cash-out refi is its ability to advance a household economically. It is an investment of earned equity into the future. Like every financial transaction, it should always make sense.
Higher education, health care, home renovation/reconstruction. credit card balances or unexpected legal bills can put a hard financial burden on individuals and families. Taking advantage of accumulated equity with a cash-out refinance will pay off those obligations. Conversely, however, that big cash infusion effectively reduces the equity the borrower has built up.
Interest aside, if equity is 50 percent in a $500,000 home, the borrower owes $250,000. Refinancing that amount with a $50,000 cash-out provision means the ownership portion drops to 40 percent. The good news is that with good credit the rate on a cash out refinance is often close to the same rates on a rate/term refinance or new home purchase. 3
This often makes refinancing your first mortgage with cash out the cheapest overall option to consolidate debt or borrow money for home improvements such as a pool or adding a second story.
Americans owed a total of nearly 14-trillion dollars to creditors in 2019. Over a trillion of that represented credit card debt alone. On the one hand, credit cards are handy in a pinch, convenient and helpful to build a positive borrowing history. Conversely, they are so easy to use that holders lose track of how much they spend and become overwhelmed by outstanding balances.
Combined with the very high interest and surcharges associated with plastic, these obligations can drown consumers if they are not careful.
Equity in a WA house can stop the downward spiral through a cash-out refinance. Since credit card interest rates have hovered lately between 16 and 21 percent — whereas conventional mortgage rates have remained around 4 percent — retiring the revolving personal debt from credit cards reduces the financial pressure on the family budget and gives way to a single, lower-interest mortgage payment.
Remodeling and renovation funded by a cash-out refinance has several benefits. Although the cash disbursed subtracts from the borrower’s equity, physical improvements will add value to the property. By itself, the loan will raise the LTV ratio. Nevertheless, rehabilitating and upgrading the house lowers LTV by raising the overall value. In this way, the use of the proceeds offsets the loss of equity.
Depending on the ambition of your home improvement plans, they can largely be funded by refinancing the property and taking cash from the transaction. There are, in fact, any number of renovations and upgrades that positively impact the value of a house and the land. New landscaping can return twice the investment in terms of property worth; exterior refreshments like painting or new siding add nearly that much.
The same goes for turning attic storage space into a bedroom or remodeling the master bath. Market value shoots up when these, and similar, modifications are made.
Equity is also a good means to expand real estate holdings. If income and assets allow, a cash-out refinance can provide the down payment on a second home or an income-producing property. The loan underwriters will want the numbers to demonstrate profit on an investment property; a second home mortgage will increase the debt-to-income ratio.
With these caveats in mind, refinancing to buy real property assets can likewise serve the borrower’s financial interests. Getting the best information from mortgage consultants and financial advisers should precede any assumption of additional indebtedness.
The cash-out refinance is a versatile loan meeting diverse financial needs. There are, of course, other avenues that may or may not be worthwhile to pursue.
A second mortgage looks very much like the first: often a fixed rate loan amortized — or paid off in regular installments — right from the start of the loan term, 15 or 30 years e.g. However, the application is underwritten with the first mortgage in mind, i.e. loan-to-value ratio is combined with the outstanding balance on the first mortgage (CLTV).
So, if a house worth $500,000 has $100,000 left on the first mortgage, the LTV sits at 20 percent. Should the owner take a second mortgage for $50,000, the CLTV will be 30 percent. It is against that figure that the application is measured.
Rates on a second mortgage are generally higher than rates on first mortgages due to the increased risk for the lender being in second lien position. Additionally second mortgages are not backed by government agencies such as Fannie Mae, Freddie Mac, HUD, or the VA.
Interest charges for HELOCs are lower than personal, unsecured credit lines. During what is known as the draw period, borrowers can take from the line what they need for their purposes — either the full line of credit or only part of it. Only interest needs to be paid back during the draw period. When the subsequent repayment period commences, no further draws are allowed and repayment will include principal and interest. Of course, as with mortgages, the credit will come with closing costs and associated fees.
Home Equity Lines of Credit rarely have a fixed rate option which makes them risky if you are borrowing large sums of money long-term. A HELOC is a perfect tool to have in place in case of an emergency or unexpected economic opportunity, but other options such as a cash out refinance will often be a better way to go if you need to borrow the money long-term.
Clearly, the cash-out refinance has numerous pluses, especially when proceeds are used wisely. Yet experienced hands in home finance know that one should never say never. Talking with experienced loan officers who understand the ins and outs of mortgage operations — is the best way to determine the best course of action. When they can hear the goals and concerns of borrowers, these professionals can better fit them into the most advantageous loan.
Sammamish Mortgage has been since 1992 and is proud to offer our expertise to you. Based in the Pacific Northwest, Sammamish Mortgage provides mortgage loan programs in Washington, Idaho, Colorado, California and Oregon. You can Contact Us for a rate quote, and we can even explain the entire process to you. If you’d rather View Rates on our website, you can, or you can even Apply Instantly or get a Rate Quote.
Whether you’re buying a home or ready to refinance, our professionals can help.
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