As interest rates fell to historic lows in 2012, U.S. mortgage refinancing exploded to $1.25 trillion in total volume, up nearly 50% from 2011. And while interest rates have risen by a full point since April, 2013 – causing a sharp decrease in refi volume for the year – it may still make sense to refinance your mortgage, especially if your fixed interest rate is 5% or higher.
If you do choose to refinance, there are two main types of loans to consider: Cash-Out and Cash-In. Let’s take a closer look at their similarities and differences to help you choose the one that is best for you.
Cash-Out Refinancing Loan
When you choose cash-out refinancing, you are refinancing your home mortgage for more than the amount you owe, and keeping the cash difference. For example, if you owe $80,000 on a $150,000 mortgage, you could find a lower interest rate, refinance your property for $100,000, and take the extra $20,000 to use as you please.
Although similar, be aware that cash-out refinancing loans are not the same as home equity loans. Generally speaking:
- A cash-out refinance loan will require you to pay closing costs; a home equity loan will not.
- A cash-out refinance replaces your current mortgage; a home equity loan is added to the amount you are already paying on your mortgage.
Is a Cash-Out loan right for you? Before making the decision, plan how you will spend the money you will receive from your cash-out loan. Remember, it is replacing your current mortgage, so it makes sense that the money is spent on something substantial – such as an addition to your home or a life-saving medical procedure not covered by your insurance. If you blow the money on an expensive new car or Mediterranean cruise, remember that you will be paying for it years after the novelty has worn off.
Cash-In Refinancing Loan
Put simply, a cash-in refinance is the opposite of a cash-out refinance, although both can help put money in the pockets of the mortgage holder. With a cash-in refinance loan, the mortgage holder — often underwater on his or her mortgage — actually puts money into the mortgage to bring their loan-to-value (LTV) ratio down to a point where they can qualify for lower-interest refinancing.
It may sound counter-productive, but in the long run, shaving a few interest points off of your mortgage payment can add up to a lot of money over the course of the loan.
A cash-in loan can also work for the mortgage holder who wishes to avoid paying private mortgage insurance (PMI) premiums, which can add considerably to a monthly loan payment. Banks and other mortgage lenders usually require PMI if the LTV ratio on the mortgage is more than 80% because the borrower cannot come up with a 20% down payment on their home loan. If you can bring cash to the table to bring your LTV up to 80%, you will avoid the PMI and save thousands over the life of your loan.
Is a Cash-In loan right for you? Before choosing a cash-in refinancing, determine if the rate of return on the money you use to pay down your mortgage balance (and boost your LTV) could go to better use in another form of investment. In general, the longer you stay in your home, the better the return on investment will be. Don’t wind up cash poor; make sure you keep a cushion of a few months living expenses in case of a rainy day, such as unexpected job loss.