With mortgage rates at historic lows, a growing number of homeowners are calling up lenders to inquire about refinancing their loans. But instead of tapping home equity to take out money for personal projects, many borrowers will do the opposite. They'll opt for a "cash-in refinance" to help pay down mortgage costs and lower loan balances.
According to a Freddie Mac quarterly analysis on refinancing, a near-record 22 percent of all homeowners who recently refinanced mortgages brought money to the closing. (In comparison, only 5 percent of refinancings were "cash in" during the real estate bubble days of mid-2006).
A cash-in refinance can be a good thing. Keith Gumbinger, a mortgage analyst and Vice President of HSH.com, says if homeowners have the funds, putting the money toward a new mortgage could mean lower interest payments in the future. However, some homeowners would need to come up with several thousand dollars before they could gain an advantage from refinancing. "For many borrowers it's almost the equivalent of making a new down payment on their home," says Gumbinger. "Homeowners will need to sit down beforehand and figure out how long it would take them to benefit."
Would a cash-in refinance be beneficial for you? Consider these pros and cons.
4 reasons to bring cash to the closing table
- Easier loan approval. Since the values of many homes have dropped substantially in recent years, it's harder for homeowners to qualify for a refinance. Bringing in cash could help borrowers lower the total loan amount and improve their loan-to-value (LTV) ratio, which would make it easier to get approved for a loan. (An LTV maximum of 80 percent is standard, but higher LTV loans are often available.)
- Eliminate private mortgage insurance (PMI). If homeowners didn't have a down payment of at least 20 percent of the purchase price when they originally bought their home, the lender probably required PMI. This insurance, which costs about 1 percent of the loan amount each year, protects the lender in case the borrower defaults.
If bringing cash to the closing table in a refinance enables the homeowner to reach the 20 percent threshold, they could eliminate PMI and save thousands of dollars in insurance payments over time.
- Push the loan "above water". Even though interest rates are low, lenders won't approve a refinance if a homeowner is "underwater," meaning more money is owed on the property than it's worth. However, if the borrower is only slightly underwater and has enough cash to pay down the balance and eliminate negative equity, the owner could then refinance out of an underwater situation by bringing the extra funds to the closing table.
- Earn a better interest rate. If homeowners have extra cash, they could place their money in savings accounts or certificates of deposit (CD), but those accounts are currently earning only about 1 percent in annual interest.
If borrowers instead put the cash toward their mortgages with cash-in refinancing, they'd save money on their interest payments, where current rates are hovering around 5 percent. Assuming money saved is money earned, homeowners would earn nearly five times more by paying down their mortgages (5 percent) than they would by putting their money into savings (perhaps 1 percent).
2 reasons to keep your cash.
Before deciding on a cash-in refinance, you should also consider the drawbacks.
- Longer break-even period. Every time borrowers refinance, they have to pay origination fees, title search and attorney expenses. It could take a couple of years before borrowers pass the "break-even" point, which is when the amount of money put into a loan is recovered by the savings from refinancing, says Gumbinger. If homeowners bring additional cash to the closing table, they extend their recovery point further into the future.
Before agreeing to a refinance, Gumbinger suggests that borrowers calculate their estimated break-even timeframes by using a refinance calculator.
- Cash-in money may be expensive. In addition to the costs involved in a refinance, Gumbinger says borrowers need to consider how much they'll pay to access the money they intend to take into a refinance.
"If you have to borrow money from your 401(k) in order to come up with the cash, you'll have recovery or repayment costs. If you're selling stocks, there may be a capital gains tax," he says.
Homeowners should carefully consider the costs and benefits of a cash-in refinance. If borrowers have access to cash and a reasonable break-even period, they could save big bucks in future mortgage costs.
More help from HSH.com
Can we do a "cash-in" refinance?
How do I remove or add a name to a home loan?In general, the only way to remove a name from your mortgage will be to refinance or pay off the debt. This is also true when trying to add names to the mortgage. Lenders will not add nor remove names from such an obligation without the opportunity to ensure that the other borrowers have the ability to pay.
I'm an inexperienced refinancer. What can I expect?Q: I owe 56,000 on my eleven year old variable rate mortgage at 8%.I have good credit, have been in my home for 11 years and want a 15-year fixed-rate mortgage. While I have a good income, I have no cash for closing costs. Do I need to pay points and fees? Do I need an appraisal? What can I expect when I approach the bank for a refinance?A: If your credit is good and you have equity in your home, you should be able to refinance to a 15-year fixed rate. Lenders will require an appraisal of the property, but you should be able to build the cost of refinancing into the loan amount, or might be able to trade it off in exchange for a slightly higher-than-market interest rate. As the bank about your loan options, and expect that you'll need to fully document your income, debts and assets.
I'm trying to refinance a jumbo loan.
Is there a ten year refinance mortgage out there?Almost any lender that offers a fixed-rate mortgage will offer a 10-year mortgage. Mortgage rates for a 10-year mortgage usually aren't any better than the rates offered for a 15-year mortgage. That said, be sure to shop around to find a competitive rate. Getting a fixed-rate mortgage with a term as short as 10 years will save you a lot of money on interest costs.