A cash out refinance converts home equity to cash by refinancing into a higher new mortgage amount pocketing the difference. When considering a cashout refinance, borrowers should also understand the limited cash out and no cash out refinances as well.

No Cash Out, Limited Cash Out, & Cash Out Refinance

To get started let's name the three types of refinances then discuss them below:

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1. The No Cashout Refinance
2. The Limited Cash Out Refinance
3. The Cash Out Refinance

A no cash out refinance is defined as a refinance where the new mortgage amount is the same as the one be paid off or replaced. That means you pay all the closing costs and escrows at closing out of your own pocket. In reality, this is rarely done. Most folks don't have the money needed to cover the closing costs out of pocket and even if they do, they have a better use for the money than pay closing costs.

A limited cash out refinance meets the definition of “limited cash out” when you technically do not take any cash out (actually you can take a limited amount…hence the name) making the new mortgage amount no more than the old loan balance plus total costs of the refinance plus the limited cash back (which is calculated as the lesser of 2% of the new loan amount or $2,000) to the borrower. In practice, this type of loan is the most popular type of refinance and is closed much more often than the no cash out one, because you get roll your closing costs into the new mortgage. Even though you could pocket up to the lesser of 2% or $2,000 of the new loan amount, most of the borrowers using these loans do not take advantage of that fact.

For example, let's say you wanted to refinance a $200,000 mortgage using a limited cashout refinance. Let's further assume the total of all the costs was $5,000. So, you could have two different refinance amounts and still meet the definition of limited cash out. The first option would be to simply and only roll in the costs…so your new amount is $205,000.

Or, you could opt for rolling in the costs AND taking your limited - 2% or $2000 cash as well - making the loan amount $207,000 in this case since you've hit the cap of $2,000. Why don't more folks take the $207,000 vs. the $205,000 as they both are “limited cash out” refinances?

I don't know. Maybe folks simply don't know they could take a little money out at the closing or they don't want to increase their loan amount…but the fact remains even though this is very popular type of refinance, the limited cash out option is seldom used. Borrowers are often confused by the name since they opt to not take any cash, yet they see the name “Limited Cash Out” on their paperwork.

Lastly, a cash out refinance meets the definition if the new loan exceeds the old loan amount by more the limited cash out definition. So, in the example above, any new refinance loan amount over $207,000 would automatically fall into the “cash out refinance” category.

You also automatically fall into the cash out category if you are paying off a second mortgage or other debts with the refinance proceeds. When you refinance a first mortgage together with a home equity loan or second mortgage, that is a cash out refinance. When you pay debt with the proceeds on a debt consolidation loan, that is also a cash out refinance.

There is a Loan-To-Value restriction on cash out refinances. You are capped at 85% loan to value for a cash out refinance of an owner occupied home. This is called the maximum cash out LTV. For an investor property, the max cash out is 75%.

For example, your home is worth $300,000 and your current mortgage balance is $200,000. You can increase your new loan amount all the way up to $255,000 which is 85% loan to value (LTV). That means you can “cash out” $55,000 minus closing costs. So in the example above, your closing costs are $5,000 and your cash back is now $50,000. If you choose to increase your rate to pay closing costs, then you would get $55,000.

Cash Out Refinance Rates

Most of the time you just get told the rates for a cash out are higher than no cash out. But that is not the whole truth. A cash out refinance is more expensive but it does not have to be a higher rate.

A cash out refinance has an add on. Depending on your FICO score and LTV, it can be pretty expensive. The add on is an expense you pay as part of your closing costs or increase the rate to pay it. A limited cash out refinance does not require the expensive cash out add on expense. And a cash out refinance investment property add on is going to be even more because you have to pay for both the investment aspect and the cash out and you are capped at 75% loan to value.

Also, if you are expecting to walk away with money at closing, that won’t happen. You won't get your cash the day you sign. Since it is a refinance, the 3 day right of rescission applies so you won't get your cash until the 3 days have past. This restriction is only for home owner refinances, not investment property refinances.

If you want to see what your payment will be with a cash out refinance, we have debt consolidation and refinance savings mortgage calculators.

Cash Out Questions Answered

Is getting a cash out refinance before intentionally defaulting on the mortgage fraud?

A mortgage loan is considered a long-term obligation made in good faith. Hiding the real intention at application in my view is mortgage fraud. This could also be considered theft. Intentionally taking the cash out refinance proceeds and then immediately defaulting is probably legally more like grand theft…or theft by fraud…or any number of crimes.

Of course, I must add my typical disclaimer here…seek actual legal advice from an attorney as I am not an attorney before making any decisions.

Should you use a cash out refinance to pay for an addition on your home?

Everyone’s situation is different but here is my general advice.

A first mortgage cash out refinance should most likely be avoided since the loan amount will be much bigger than the cash needed and therefore all the costs will be correspondingly bigger as well.

This advice would change if your existing first mortgage has some “bad” terms like an adjustable rate or a balloon payment you'd need to get rid of anyway. A cash out refinance in that case would kill two birds with one stone.

The best way is usually a home equity loan of one kind or another. Then you can draw off it when you need it.

I hope this articles gets down to the nitty-gritty on cash out refinances for both home owners and investors.

Good Luck!


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