Mortgage Matters

Many homeowners refinance to use the equity in the home for personal or business needs. Today's low interest rates help create excellent and valid logic for "cash-out" refinances.

Refinancing to pay off an existing second mortgage or taking cash out of the home's equity in order to pay off credit cards are the most popular reasons for cash-out loans. Credit-card interest payments are far higher than today's home mortgage rates and of course the home mortgage is deductible. Refinancing to a new cash-out mortgage to finance college educational expenses can also be a valid reason for refinancing. The homeowner gets a very low interest rate, the tax deduction, and does not disturb existing savings and investment accounts.

Many homeowners have found when remodeling their home that financing costs can be more economical by using a home-equity line of credit rather than a construction loan. Construction loans have extra costs of implementation that are not found in the home-equity loan.

Several of my recent clients have used cash-out loans to pull cash out for the purchase of an investment property rather than using their liquid savings. This method of financing a new real-estate investment creates a transaction that in many cases requires no down payment at closing.

Surprisingly, lenders make a distinction between refinancing to pay off an existing mortgage and funding the same loan amount directly to the homeowner. These lender rules are only logical to the lender world.

Most borrowers, unaware of this prejudice, are astonished that limitations on refinancing to retrieve equity in a home are more restrictive than refinancing an existing mortgage.

Recently a borrower purchased a new home for 0,000, all cash with no mortgage, and later found it very difficult to refinance and borrow 80 percent of the purchase price. Although qualified, with excellent assets and income and wonderful credit scores, the lender would only fund a cash-out loan of 0,000.

Two factors drive the determination of cash-out loans: its LTV (loan amount as a percentage of the value) and the total amount of the loan. Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) loans use a simple formula. Of course, they are limited to a maximum of 0,700 but the only restriction on cash back is the loan-to-value. A 0,000 home could be refinanced for a cash-out amount of 7,000 (90 percent of the value).

Jumbo loans (those above 0,700) are offered by lenders who do not sell loans to Fannie Mae and Freddie Mac and therefore do not follow guidelines set by Fannie and Freddie for jumbo loans. Typical restrictions on jumbo cash-back loans would be 0,000 with an LTV of 80 percent, 0,000 with a 70 percent LTV, and possibly 0,000 with a 50 percent LTV. A homeowner with a home valued at million and no mortgage will have difficulty obtaining a mortgage at market rate to cash out a meaningful amount of the equity.

Stated-income or no-doc loans carry an even more restrictive amount of cash out that can be returned to the homeowner. Some programs stop at 0,000 no matter what the LTV is for the property.

Plan ahead when purchasing a home and avoid paying cash for the house unless absolutely certain that you will not want to retrieve equity by refinancing in the future.

Related links:

1. Mortgage rates hit record lows; can it be time to refinance again?
2. Remodeling the debt
3. If you're considering refinancing, examine all the options