Interest rates for a “cash-out refinance” can easily be 1/2 percent higher than interest rates for a “rate-and-term refinance.”
This is particularly true for higher loan-to-value ratios and lower credit scores.
A cash-out refinance is a refinance where borrowers increase their loan amount to receive cash, which can be used for most anything.
There is a way, however, for borrowers to effectively receive substantial “cash” without incurring the huge cash-out cost that comes in the form of a higher rate.
Note to agents: This is a short and educational reminder about how refinances work – even if you’re not looking to take cash out. It’s also great info you can share with your clients.
SIDEBAR: Putting today’s rates in perspective: The “average” interest rate today is 6.34%, about 1/4% higher than the “bottom” we saw last week… right before Fed Chair Powell pulled the plug on all the fun with his comments about not cutting in December. So yes, rates are a bit higher now. But, rates were over 7.0% last year at this time. So, things remain pretty golden.
The Non-Cash-Out Cash-Out Loan
A friend of mine is recommending this scenario for his borrowers in the DC area suffering from the government shutdown – and it works like this.
Borrowers can lock in a “rate and term” refinance now, skip December’s and January’s payments, and get 1% of the loan amount as cash back (Fannie Mae’s maximum amount allowed without the loan being deemed “cash out”).
Reminders:
- When lenders offer “no cost” refinances, it usually means that they pick up non-recurring closing costs (one-time fees) only, such as title insurance, escrow fees, appraisal fees, underwriting fees, etc. Lenders do not cover “non-recuring closing costs” such as prepaid interest, insurance and property taxes – which can be substantial.
- A rate and term refinance can finance all closing costs (recurring and non-recurring), and it will NOT be deemed “cash out.” Closing costs, once again, include prepaid interest, homeowners’ insurance, and property taxes.
- Every mortgage payment covers the interest that was accrued over the previous month – meaning interest is paid in “arrears.”
- When borrowers refinance, though, they pay interest through the end of the month in which they close, eliminating the payment due for the following month.
Hence, a hypothetical borrower with a $600,000 loan balance, a $10,000 property tax bill, and $2,500 insurance premium due – could close in early December with a loan amount as high as $625,000 – and it would not be deemed “cash out.”
- Loan closes early December.
- New loan pays November interest (eliminating December payment)
- New loan pays interest through the end of December (eliminating January payment)
- First payment will be due Feb 1st.
- The $35,000 added to the loan will be absorbed by property taxes ($10,000), insurance ($2,500), November interest (estimated $3,500), December interest (estimated $3,000), and the allowable 1% of the loan amount ($6,300).
- Borrowers will have NO payments for December and January.
So, even if property taxes and insurance are not due, just eliminating two housing payments can be an enormous relief.
