If you have equity in your home, you may be eligible to tap into it with a cash-out refinance. This refinance gives you a loan for a higher amount than what you owe. The difference between what you owe and the new mortgage amount is the cash you receive. Below we discuss how much cash you can take out and the pros and cons of doing so.
The Cash-Out Refinance Limits
Generally, you can take out between 75 and 100% of your home’s value in a cash-out refinance. It depends on the program and the lender. The first step in figuring out how much you can take out is to know the value of your home. This helps you determine if you have equity in your home. Remember, home values fluctuate, so you might not know the actual value of your home right now.
Following are the program guidelines lenders follow:
- Conventional loan – 80% LTV for a 1-unit property and 75% LTV for 2-4 unit properties
- FHA loan – 95% LTV as long as you have made 12 payments on the loan. If you made less than 12 payments, you can only take out 85% of the value of the home.
- VA loan – 100% of the value of your home
The amount you may receive doesn’t depend on the program alone. Your credit score and debt ratio play a role as well. You must prove to the lender that you can afford the payments and have a history of making timely payments. A lower credit score or higher LTV could lower the limit a lender gives you.
Figuring Out Your LTV
Before you apply for a cash-out refinance, you must know what your home is worth. You can talk to a lender or real estate professional to get an idea. You won’t officially know the value of your home until you pay for an appraisal, though. You’ll also need to know the amount of your outstanding balance eon your current loan. Once you know these figures, you can determine your LTV by the following calculations:
Current Home Value x maximum allowed for the program = Total allowed loan amount
Total allowed loan amount – outstanding principal balance on your current loan = Cash limit for the cash-out refinance
The Benefits of the Cash-Out Refinance
You may experience several benefits when you take cash out of the equity of your home:
- Tax deductions – You can usually write off any interest you pay on a 1st mortgage, even a cash-out loan. This helps reduce your tax liability and can offset some of the closing costs you pay for the loan.
- Gets you organized – If you use the cash-out loan to consolidate debt, it can help you stay organized. You only have one payment to handle each month.
- Low interest – The interest rate on a first mortgage is usually lower than those on a 2nd mortgage, personal loan, or credit card.
The Downsides of the Cash-Out Refinance
As you probably guessed, there are some downsides to taking cash out of your home as well:
- Starting over – Depending on the term you took, you could be starting all over again on your loan term. For example, if you paid on your current loan for five years but you take out another 30-year loan, those five years are erased.
- Closing costs – Mortgages cost money to process and close. Unless you find a lender that will negotiate a no-closing cost loan, you will pay for the cash. This could eat away at your profits.
- Risk of foreclosure – You put your home at risk when you take cash out of the equity. If you miss payments on your mortgage, the lender can take your home. If you used the money for things that don’t’ have anything to do with the home it could be risky.
- Interest payments – Adding other debts into your mortgage means you pay on the loan for longer periods. For example, throwing credit card debt onto your mortgage means you’ll pay interest on that debt for the next 30 years. Chances are you wouldn’t hold onto the credit card debt for that long. The debt may then cost you more.
Is it Smart to Take Cash out of Your Home?
Given the pros and cons, is it smart to take cash out of your home? It depends why you need the money. Are you in a bind financially? Do you need to consolidate debt? Are you improving your home? Can you get a lower interest rate? These are a few questions you must ask yourself.
Generally, taking cash out of your home for anything but home improvements isn’t a good idea. It puts your home at risk and costs you more in the long run. If, however, you use the money to improve your home, you’ll likely see a return on your investment. When you sell the home, you’ll get some of the money back, but probably not all of it.
This isn’t to say you should never take cash out of your home if you need it. You just need to be smart about it. Don’t take more than you need. If you consolidate debt, make sure you don’t reuse the credit cards you just paid off. This only starts the cycle all over again. Only this time, you’d have double the debt.
The Bottom Line
The loan program you have helps determine the limit of cash you can take out of your home. Don’t think you should that you have to take out the full amount. Only borrow what is necessary. Think long and hard before taking money out for a vacation or even a college education. There may be other, less expensive ways to pay for those things.
If you do take cash out of your home, make sure you get the best interest rate. Shop around and see what different lenders offer. Some have higher thresholds than others. This way you can have access to the money tied up in your home.