What is cash-out refinancing, and how does it help you?

What is cash-out refinancing, and how does it help you?

Looking for ways to diversify your investments by buying an investment property or shares? You may be considering refinancing. 

You may even be thinking of renovating, expanding your kitchen or perhaps adding a new room. All of these are ways you can leverage the equity you’ve built in your house and use the cash to build wealth. 

Refinancing your home loan can sometimes also be called cash-out refinancing. This basically means that you’re tapping into your home equity by refinancing your mortgage for a larger one, allowing you to take out the extra money as cash. 

For example, suppose you took out a $400,000 mortgage to buy a property worth $500,000 several years ago. Presently, you’re left with an outstanding debt of $200,000. Assuming that the property’s value has not fallen, you’ve built up $300,000 in home equity. Now, you want to convert $50,000 of your equity into cash to pay for a home renovation project you’ve been planning. 

One of the options that you may be able to consider is to refinance your home loan to access this equity. If you choose this option, you can take out a new mortgage of $250,000. The new mortgage would include the $200,000 outstanding from your original mortgage and the $50,000 that you’ve taken out as cash.

Some lenders will let you access the money as a flexible line of credit instead of a lump sum payment meaning you get periodical payments when needed. Like other mortgages, the typical repayment term offered is 30 years with a choice between fixed and variable cash-out refinance mortgage rates.

Home equity loan and cash-out refinance: What’s the difference?

Cash-out refinance loans, and home equity loans are two different options to leverage the equity you’ve built in your property. 

A cash-out refinance mortgage is a brand new mortgage with a higher loan amount than what you previously owed on your house. Generally, you’ll be able to do a cash-out refinance if you’ve had your property long enough to build equity or its value has risen. 

On the other hand, a home equity loan is a second mortgage that doesn’t replace your existing mortgage. If you’re taking out a home equity loan, you’ll be taking out a second mortgage that will be paid separately, usually at a fixed rate of interest. 

While both the products let you tap into your home equity, cash-out refinances are often cheaper. This is because you’re taking out a new loan, meaning it’ll be paid off first if your property is foreclosed on or you declare bankruptcy.

What is the benefit of a cash-out refinance?

Borrowing cash while refinancing may help pay the deposit for a second property, fund a large purchase, or consolidate debts like credit cards and personal loans. You could also use the money for a home renovation project by opting for a line of credit, which is more suitable if you need the money in instalments. 

With a line of credit, you can borrow and repay the extra money on a need-basis, only paying interest on the money withdrawn by you. Some lenders will also allow you to invest the money in shares or purchase a new business, but this is decided on a case-to-case basis. It may be dependent on the level of exposure a lender is comfortable with. 

How much can I borrow with a cash-out mortgage refinance?

Typically, you’ll be able to borrow up to 80 per cent of a property’s value with a cash-out refinance loan. This means you’ll have access to the cash amount or equity that is the difference between what you still owe and 80 per cent of your property’s value. 

However, most lenders will ask you to state the purpose of the loan when applying to assess their risk. This is because lenders don’t control how you’ll use the funds once they hit your bank account. Lenders want to evaluate if you’re a mortgage holder living beyond your means. 

Your lender wants to be sure about what you’re going to do with the money before approving your mortgage refinance application. Once the money is accessible, you might be tempted to use it for other things, which could make your financial situation worse. 

Lenders also require proof that you’d be able to meet the repayments for a higher amount of debt. They want to minimise their risk while ensuring your new mortgage won’t put you under any financial stress leading to repayment issues. If you think you’re falling behind with your repayments, or looking to refinance to free up some cash for meeting your day-to-day expenses, it might be best to speak with a mortgage broker to work out a suitable option. 

Tapping into your equity may help consolidate your loans, but it might not be an effective strategy for mitigating financial stress in the long run. Also, if you’re extending the loan term, you’ll end up paying more interest, increasing the total cost of the loan. Speaking with an expert can help you make an informed decision.

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Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

How do I refinance my home loan?

Refinancing your home loan can involve a bit of paperwork but if you are moving on to a lower rate, it can save you thousands of dollars in the long-run. The first step is finding another loan on the market that you think will save you money over time or offer features that your current loan does not have. Once you have selected a couple of loans you are interested in, compare them with your current loan to see if you will save money in the long term on interest rates and fees. Remember to factor in any break fees and set up fees when assessing the cost of switching.

Once you have decided on a new loan it is simply a matter of contacting your existing and future lender to get the new loan set up. Beware that some lenders will revert your loan back to a 25 or 30 year term when you refinance which may mean initial lower repayments but may cost you more in the long run.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.

Will I be paying two mortgages at once when I refinance?

No, given the way the loan and title transfer works, you will not have to pay two mortgages at the one time. You will make your last monthly repayment on loan number one and then the following month you will start paying off loan number two.

If I don't like my new lender after I refinance, can I go back to my previous lender?

If you wish to return to your previous lender after refinancing, you will have to go through the refinancing process again and pay a second set of discharge and upfront fees. 

Therefore, before you refinance, it’s important to weigh up the new prospective lender against your current lender in a number of areas, including fees, flexibility, customer service and interest rate.

Can I refinance if I have other products bundled with my home loan?

If your home loan was part of a package deal that included access to credit cards, transaction accounts or term deposits from the same lender, switching all of these over to a new lender can seem daunting. However, some lenders offer to manage part of this process for you as an incentive to refinance with them – contact your lender to learn more about what they offer.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Cash or mortgage – which is more suitable to buy an investment property?

Deciding whether to buy an investment property with cash or a mortgage is a matter or personal choice and will often depend on your financial situation. Using cash may seem logical if you have the money in reserve and it can allow you to later use the equity in your home. However, there may be other factors to think about, such as whether there are other debts to pay down and whether it will tie up all of your spare cash. Again, it’s a personal choice and may be worth seeking personal advice.

A mortgage is a popular option for people who don’t have enough cash in the bank to pay for an investment property. Sometimes when you take out a mortgage you can offset your loan interest against the rental income you may earn. The rental income can also help to pay down the loan.

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

Is a home equity loan secured or unsecured?

Home equity is the difference between its current market price and the outstanding balance on the mortgage loan. The amount you can borrow against the equity in your property is known as a home equity loan.

A home equity loan is secured against your property. It means the lender can recoup your property if you default on the repayments. A secured home equity loan is available at a competitive rate of interest and may be repaid over the long-term. Although a home equity loan is secured, lenders will assess your income, expenses, and other liabilities before approving your application. You’ll also want  a good credit score to qualify for a home equity loan. 

Can I borrow extra on my mortgage for furniture?

Yes, you may be able to borrow extra on your mortgage for furniture. This may be done by considering a home equity loan. A home equity loan may allow you to access the equity in your mortgage for furniture via:

  • A line of credit – A pre-approved credit limit based on your equity.
  • A lump sum payment – Like a persona loan, with equity in your home loan used as security.

If you want to avoid borrowing more money, consider accessing cash deposited into your offset account or drawing down on extra repayments with a redraw facility to fund furniture purchases.

What is equity? How can I use equity in my home loan?

Equity refers to the difference between what your property is worth and how much you owe on it. Essentially, it is the amount you have repaid on your home loan to date, although if your property has gone up in value it can sometimes be a lot more.

You can use the equity in your home loan to finance renovations on your existing property or as a deposit on an investment property. It can also be accessed for other investment opportunities or smaller purchases, such as a car or holiday, using a redraw facility.

Once you are over 65 you can even use the equity in your home loan as a source of income by taking out a reverse mortgage. This will let you access the equity in your loan in the form of regular payments which will be paid back to the bank following your death by selling your property. But like all financial products, it’s best to seek professional advice before you sign on the dotted line.

What are the features of home loans for expats from Westpac?

If you’re an Australian citizen living and working abroad, you can borrow to buy a property in Australia. With a Westpac non-resident home loan, you can borrow up to 80 per cent of the property value to purchase a property whilst living overseas. The minimum loan amount for these loans is $25,000, with a maximum loan term of 30 years.

The interest rates and other fees for Westpac non-resident home loans are the same as regular home loans offered to borrowers living in Australia. You’ll have to submit proof of income, six-month bank statements, an employment letter, and your last two payslips. You may also be required to submit a copy of your passport and visa that shows you’re allowed to live and work abroad.

When do mortgage payments start after settlement?

Generally speaking, your first mortgage payment falls due one month after the settlement date. However, this may vary based on your mortgage terms. You can check the exact date by contacting your lender.

Usually your settlement agent will meet the seller’s representatives to exchange documents at an agreed place and time. The balance purchase price is paid to the seller. The lender will register a mortgage against your title and give you the funds to purchase the new home.

Once the settlement process is complete, the lender allows you to draw down the loan. The loan amount is debited from your loan account. As soon as the settlement paperwork is sorted, you can collect the keys to your new home and work your way through the moving-in checklist.