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A cash out refinance of your mortgage loan is a good idea if these four statements describe your homeownership situation:
- I have a healthy amount of equity in my home.
- I could use some of that equity for important financial uses (paying down other debts, home improvements, etc.).
- I qualify for a lower mortgage rate.
- I qualify for a cash out refinance loan.
How do you qualify for a cash out refinance mortgage loan?
It’s this fourth item that we would like to focus on in today’s article. Let’s take a look at the qualification factors that most mortgage lenders will review. These are the standard requirements you must meet in order to qualify for a special type of home loan that allows you to cash out part of your equity while refinancing your mortgage at a lower interest rate.
Most home refinance loans require a credit score of at least 580. However, you should aim to have a credit score of 620 or higher if you want to qualify for a cash out refinance. The requirements may vary from lender to lender and you may be able to qualify based on other factors. This is typically the standard FICO score benchmark for cash out refinancing.
Debt-to-Income Ratio (DTI)
To calculate your DTI, you will add up all your monthly debts and bill payments and divide that total by your monthly income amount. Let’s say you pay $2,000 in bills every month (including your current mortgage payments) and you make a monthly salary of $5,000. Your debt-to-income ratio would be $2,000 divided by $5,000, which is a DTI of 40%.
If you are looking to refinance your home loan, you will generally need a DTI of less than 50%. In other words, your total monthly bills shouldn’t add up to more than half of your monthly income. Those who exceed this threshold may have a difficult time qualifying for a home refinance loan, especially any mortgage refinance program that allows you to take cash out from your home equity.
Here comes the most important part of cash out refinancing. You must have a sizable amount of equity in your home if you want to qualify for this type of mortgage loan. If you are upside-down on your mortgage, you will certainly not be able to get a cash out refinance. The same is generally true if your equity is not significant enough. What is considered “sizable” may vary from lender to lender and from loan to loan. It’s all relative to the home’s value, the size of your original loan and what you still owe in principal on that loan.
No lender will allow you to take out 100% of your home equity in a cash out refinance. There is too much risk involved in that scenario because there is never a guarantee that the property will continue to go up in value or hold its current value. There should be a generous buffer amount between the current appraised equity and what you ask to cash out when refinancing.
How Much Equity Can I Cash Out?
To determine your equity, the lender will hire a third-party home appraiser to calculate the current market value of your property. Then, they would subtract that appraised amount by the principal you currently owe on your existing mortgage loan. For example, your property appraises for $400,000. You originally borrowed $300,000 and you still owe $250,000 of principal. That means you have $150,000 in equity. Relative to the value of your home, this would be considered a sizable amount and you would probably be in good shape to cash out some of that equity (assuming you meet the other loan qualifications).
In this scenario, you wouldn’t be able to take out all $150,000 of your equity. You might be able to take out as much as $100,000. It may depend on how much risk the lender is willing to take and other factors.
The real important question to ask yourself is how much do you really NEED to take out? You should never cash out more than you actually need. If you only need $50,000 to take care of home repairs or renovations, then apply for $50,000. Taking out extra won’t help you in any way. It’s best to keep as much as you can in the property to let it continue gaining equity until it’s time to sell the house.
Other Qualification Standards
The lender will also review your current employment situation and income history. They would also determine what kind of interest rate for which you qualify. There’s no point to refinancing at a higher mortgage rate than you already pay. Make sure you are reducing your rate before even considering a cash out refinance. In general, a cash out refinance rate may not be as low as a standard refinance rate. This is because you are adding principal to the new total loan amount. If you are refinancing for the $250,000 you still owe plus cashing out another $50,000, then your new loan principal will be $300,000. This would likely come with a slightly higher interest rate compared to refinancing for only $250,000.
Let Us Help You With More Information On a Cash Out Refinance Today!
Cash out refinancing is not for everyone. Talk with your lender to see if you qualify and to determine if it’s a smart solution based on your financial situation and cash needs. Contact us today to get started on your home refinance.