What is a cash-out refinance loan?

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A cash-out refinance loan is the refinancing of a borrower’s first mortgage into a new mortgage for more than the amount owed. The borrower receives a sum of "cash out" funds after the existing mortgage is paid in full and all closing costs are covered. The homeowner now has a new loan, usually for a new 30 or 15 year term at present day interest rates plus some cash.

Greg Cook, Certified Military Housing Specialist for First Time Home Buyers Network, told how a cash-out refinance loan works.

“If a homeowner owes, for example $200,000 and would like to get $50,000 cash out, he would then apply for a loan that would be $250,000 plus whatever the loan fees and closing costs (approximately $5000), so he or she would have a new loan at $255,000 at whatever his new negotiated interest rate would be,” said Cook. “After closing the homeowner would receive a check from the closing agent for $50,000.”

Cook explained that people who need tax free money are the ones who borrow cash-out refinance loans. However, there are some requirements.

“The first requirement to get a cash-out refinance is equity,” said Cook. “The max loan-to-value for most cash-out programs is 80 percent. In the above example, the homeowner’s property value would need to be at least $319,000.”

The money borrowers receive from a cash-out refinance can be used for home improvements, college funds, investments, or to pay off other debts. However, Cook did note that lenders get nervous should homeowners mention they intend to start businesses.

Joe Parsons, Senior Loan Officer for PFS Funding, told loans that qualifying for a cash-out refinance loan is very similar to qualifying for most other types of financing.

“The lender looks first at debt-to-income ratio (DTI),” he said. “This is calculated by adding all long-term debt payments (those that will run for 10 months or longer) to the new mortgage payment, plus taxes and insurance. This value is then expressed as a percentage of the gross monthly income. This value cannot exceed 50 percent (possibly less, depending on the borrower’s overall financial profile). A borrower who earns $5,000 could qualify for a total payment of $2,500.”

Lenders also look at borrowers’ credit scores. Parsons said that borrowers should have a FICO score of at least 640, since the lower a credit score the more costly a loan will be due to “risk-based pricing”, which is when adjustments are made to a refinance loan price based on a borrower’s credit score.

Parsons explained that risk-based pricing can prove costly for cash-out refinance loan borrowers who do not have high credit scores.

“With a 640 score, the borrower will have a rate of 4.75 percent for a loan and will pay “points’ amounting to around 2.5 percent of the loan amount up front,” said Parsons. “The same loan for a borrower with a 740 score or higher will be 4.25 percent with no discount points.”

Parsons also noted that, in order to qualify for a cash-out refinance loan, borrowers will have to provide verifiable documents of their incomes and assets.

(Interviews with Mr. Cook and Mr. Parsons conducted by Isaac Juarez)

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