The often quoted but seldom followed adage “Make lemonade out of lemons” seems out of place in the world of refinancing. But in fact, it is perfectly reasonable if one is considering taking out a cash out refinancing loan. A cash out refinancing loan is simply a loan that is usually based on a home’s equity that is greater than the amount actually owed on the home. The difference between the amount actually owed and the amount of the new loan is returned to the buyer in the form of a “Cash Out”. For example, suppose a married couple has paid monthly home loan payments of $ 100,000 for the past 10 years. They have now paid $ 50,000 on their mortgage and owe another $ 50,000 if the house passes to them and officially belongs to them. However, something is happening at the 10-year mark. Somebody gets sick and suddenly the couple has to raise $ 20,000 to pay the medical bills. So they opt for a cash out refinancing.
Cash Out Refinace: Das Negative
As you can probably imagine, those who do avail of a cash out refinance tend to be in financial trouble. Because this trait is quite common in people using cash out refinancing, there are higher default rates for those using these loans. This higher default rate enables banks to charge higher financing and interest rates on these loans. In the example above, a cash out refinance would typically have the lender pay off the old $ 50,000 loan and take out a new $ 80,000 loan. Then he writes the couple a check for $ 20,000 that they can use to pay their medical bills. In the meantime, they would collect $ 10,000 for completing the transaction. The lender will then offer the couple a floating rate that is, on average, significantly higher than the rate they had on their original mortgage. Ultimately, over the life of the loan, the couple will pay an additional $ 35,000 to $ 45,000 for the ability to withdraw $ 20,000 from their own money. As should be clear by now, this is usually not a good deal for the borrower.
Cash Out Refinance: The positive sides
In reality, however, it happens again and again that families need a lot of money in a very short time. Cash out refinancing is one way of getting this money. Whenever you find yourself in such a situation, you should know that there are some steps you can take to minimize the harm. First, you need to look at the total amount of refinance. Like the pair above, if you owe $ 50,000 and received $ 20,000 in cash, each refinance is over $ 70,000 (50,000 + 20,000) of money the lender is putting in their pocket. Get multiple quotes to find the lowest number. Just keep in mind that you will need to go through the contract with a fine-toothed comb to find this number as lenders usually try to hide and / or confuse it in the contract. The next and potentially most important step is to find a similarly formatted interest rate.
The refinancer’s offer
Refinancing companies often try to lure you into claiming that your monthly payment will actually go down after the Cash Out Refinance. It’s always too good to be true. What the lenders do is top up your payments so your payments can actually be lower in the first year or so. But if you look at years 5 through 10 of your loan, you will find that you are paying a lot more than you expected. They do this because they know full well that you will not be able to pay the high mortgage payments later and that the only option you have is to come back to them and refinance again. Instead, you should opt for a fixed rate mortgage. If you had a fixed rate of 8% for 15 years prior to the cash out, 20 years of fixed rate of 8% isn’t bad. It is important that you do not receive the cash-out for free with the cash-out refinancing. You are losing equity in your home and you will have to pay for it. The most important thing about making lemonade is that you are aware of how you are paying for it and that you are making the repayment responsibly and sustainably.