Getting Approved for a Cash-out Refinance
Once you’ve determined how much money you need, the search for a lender begins! Request a quote from an NMLS lender (verifying that they are a licensed mortgage lender according to national standards) and be ready to provide additional documentation to confirm you meet their requirements. Cash-out refinances are available with either a fixed or an adjustable rate, but while the Fed continues to lower interest rates, mortgage rates are currently at an all time low. You may find the fixed rate is a better option for your financial situation than a variable rate. That being said, along with greater uncertainty due to the pandemic, major banks have tightened their lending standards, making it even harder to qualify for a cash-out refinance. Closing costs for a cash-out refinance are generally higher than home equity loans or a home equity line of credit. But if your new interest rate is lower than your first mortgage, you may find that the one time costs of a cash-out refinance balance out your savings in interest.
Risks of a Cash-Out Refinance
If you’re not confident that your home will increase in value over the course of your loan term, typically 10-30 years, a cash-out refinance may not be your best option. The bank will still require repayment of the full balance of your new mortgage – even if the value of your home decreases over time- leaving you potentially "underwater." If you're nearing retirement, it's also important to take your new loan term into consideration. Even if your home value increases over time, a 30 year cash-out refinance taken out at 65 years old won't be paid off until you're 95 – potentially impacting your ability to leave it to your heirs. If a cash-out refinance doesn't sound like the best fit for you, it's worth comparing against another popular home financing option – a home equity loan.
How does a home equity loan work?
Home equity loans allow borrowers who have paid down a significant portion of their mortgage to access their home equity. Sometimes referred to as a second mortgage, these loans are one of the most common forms of home financing. When you obtain a home equity loan, a lender will provide you a lump sum which you will repay over time in monthly installments that include accrued interest. Unlike a cash-out refinance that replaces your existing mortgage with a new one, a home equity loan is considered a second lien on your home. Home equity loans generally have a higher interest rate than other traditional financing options like HELOCs, which some homeowners view as a fair tradeoff in exchange for a fixed interest rate and predictable second mortgage payments.
Requirements for a Home Equity Loan
Similar to a cash-out refinance, your credit score, your debt-to-income ratio, your income, and the amount of home equity you own all matter when you apply for a home equity loan. Lenders need to feel confident that you’ll be able to repay the loan.
Getting Approved for a Home Equity Loan
When a lender reviews your application for a fixed-rate home equity loan, they'll first review your loan-to-value ratio to make sure you have enough equity in the home to take out a second mortgage. They’ll also review your financial profile to make sure you have the documented ability to repay your new loan. If you are not a W2 employee and have a non-traditional income source, you may have to provide additional documentation to prove to the lender that you have the ability to make your monthly payments over the term of the loan, typically 30 years. While the minimum credit score is lower for home equity loans than some other forms of financing, the higher your credit score, the more likely it is that you’ll qualify for the best rates.
Risks of a Home Equity Loan
Similar to a cash-out refinance, or any other type of home financing that includes interest, it’s worthwhile to calculate the impact your loan length will have on your overall costs over time. Over 30 years, interest payments can add up quickly – and some lenders may charge a prepayment penalty if you come into a windfall, your income increases significantly, or generally have the ability to pay the loan back earlier than scheduled. Finally, as with all home financing options, tread carefully if you’re using your home equity loan to pay off unsecured debt. Financial advisors generally recommend against replacing unsecured debt like credit card bills with secured debt like a HELOC or home equity loan unless you have a solid plan to avoid future debt.