Thinking of taking on a few home improvement projects? Looking to consolidate high-interest, non-mortgage debt, or pay for your kids’ college tuition? Have you thought about a cash-out refinance?*
The option of a cash-out refinance means that a new mortgage replaces your current one, giving you cash out. It’s all based on how much equity you have built up in your home; homeowners choose to take advantage of cash-out refinancing for many reasons that require cold-hard cash. Whatever your need for a cash-out refinance, make sure that you have done your research and know about these cash-out refinance mistakes to avoid.
Refinance Mistake #1: Not Knowing The Numbers
The appraised value of your home minus your current mortgage determines your home equity. Without enough equity, you won’t be able to qualify for a cash-out refinance.
Your home equity helps mortgage lenders determine your loan-to-value (LTV) ratio — one factor that lenders consider when deciding whether to approve your loan application. LTV determines the amount of cash back you can get when you refinance. A good rule of thumb is to target an LTV that’s around 80% or less.
Calculating Loan-To-Value Ratio
LTV is one way to illustrate how much money is owed on a current mortgage. See the basic LTV ratio formula below.
Current Loan Balance ÷ Current Appraised Value = LTV
Example: Your monthly statement shows a mortgage balance of $125,000. Your home currently appraises at $210,000. So calculating your LTV would look like this:
$125,000 ÷ $210,000 = .59
Convert .59 to a percentage, and you will see an LTV of 59%.
When it comes to refinancing your mortgage, your credit score is one of the most important numbers. Generally the higher your credit score, the greater your chances of qualifying for a cash-out refinance — but it is not the only deciding factor for loan approval.Your debt-to-income ratio, or DTI, is another important number. Lenders use DTI to determine debt management. DTI illustrates how much of your income goes toward your loan payments. If your debt to income ratio is high, you might not qualify for a cash-out refinance. DTI allowances can vary across lending programs, but it is likely that if you have too much debt, you will have a challenging time finding a lender to secure a loan.
Calculating Debt-To-Income Ratio
DTI is calculated by dividing total monthly payments by gross monthly income.
Example: You have $5,000 in monthly income and your debt payments total $1,000 a month. Dividing $1,000 by $5,000 gives you a DTI of 20%.
Refinance Mistake #2: Making Big Credit Purchases
A big refinance mistake to avoid is opening new credit accounts or making large purchases on credit while also trying to qualify for a refinance. Opening new credit accounts can lower your credit score because it lowers your credit age, which accounts for 10% of your overall credit score. Making big credit purchases could also affect your debt to income ratio, which plays another role in qualifying for a cash-out refinance.
Refinance Mistake #3: Failing To Weigh Your Options
While it might be tempting to use your current lender or a friend who is a mortgage broker for a cash-out refinance because it’s convenient, they already know you, or it seems like the “right” thing to do, you might not get the best rate by doing so. Contact multiple lenders, and make sure they are communicative and help you understand your options.
Refinance Mistake #4: Not Considering All of the Costs
There are costs associated with a cash-out refinance, including closing costs and other fees that generally apply when you get a new mortgage. It could be possible to roll some of the closing costs into your new mortgage, but be sure to consult your mortgage lender and learn about all of your options.
Refinance Mistake #5: Failing to Lock Your Rate
When you talk with lenders, ask about rate lock options. Find out about the process of locking in a rate during the loan application, because it might be wiser to lock in your rate and not risk rates going up before you close. Many lenders will lock a rate for 30 to 60 days.
*A cash‐out refinance increases your mortgage debt and reduces the equity you may have in your home. Your monthly mortgage payments may be higher. A debt consolidation refinance increases your mortgage debt, reduces equity, and extends the term on shorter‐term debt and secures such debts with your home. The relative benefits you receive from debt consolidation will vary depending on your individual circumstances. You should consider that a debt consolidation loan may increase the total number of monthly payments and the total amount paid over the term of the loan. To enjoy the benefits of a debt consolidation loan, you should not carry new credit card or high interest rate debt.