Cash Out Refinance Definition
Cash-out refinance is a term used very often in the mortgage refinancing terminology.
First of all mortgage refinancing means getting a new loan which pays off the balance and replaces an existing mortgage loan, thus providing an easy means to property owners for restructuring their loans.
A property owner will be able to use cash-out refinance when he can obtain a refinancing loan that is higher than the remaining balance of the existing mortgage. For example, consider an existing mortgage with a remaining balance of £100,000. An example of a cash-out refinance arrangement would be a refinancing loan of £120,000, which will repay the remaining balance of the existing mortgage of £100,000 and allow the property owner to put in his pocket the remaining £20,000. Of course, this is not free money. These are borrowed money, which the owner will have to repay by paying loan installments.
Notice that the loan installments for the refinancing mortgage will be higher than the payments made before for the old mortgage, unless the cash-out refinance is secured with better terms compared to the existing mortgage, such as lower interest rate and/or longer term. Certainly, the ideal cash-out refinance arrangement will be the one in which the owner manages to walk away with cash back without having a higher monthly mortgage payment.
When is Cash-Out Refinance Feasible
The first precondition for cash-out refinance is that the borrower will afford to make the loan payments for the new loan, if these end up being higher than the payments for the existing loan. Assuming that the property has at least the same value it had when the existing mortgage was made, cash-out refinance may be possible under the following circumstances:
1. The owner is able to find a lender that is willing to provide mortgage refinancing at a higher Loan-To-Value ratio (LTV) than the original mortgage. For example consider a property valued at £200,000. Let’s assume that the first mortgage was made at 70% LTV, which means the lender gave a £140,000 loan. If the owner finds a lender willing to refinance at an 80% LTV, he/she will be able to obtain a mortgage refinance loan of £160,000.
2. The owner has already repaid a part of the loan principal, or in other words, the owner has some built-up equity by repaying the existing loan through the years. Thus, a refinance loan at the same LTV will allow a loan higher than the remaining balance of the existing mortgage.
3. The value of the property has increased since it was acquired by the property owner. Thus, a mortgage loan at the same LTV as the original mortgage would provide a higher amount of borrowed funds to the property owner. Consider, for example, that the property bought at £200,000 with a mortgage loan of £140,000 (70% LTV) has increased in value by 15%. So the property is now worth £230,000. This would allow a cash-out refinance by obtaining a refinancing loan at the same LTV, which would amount to £161,000.