Type 1 vs Type 2 Cash-Out Refinance

Type 1 vs Type 2 Cash-Out Refinance

Cash-out refinances can be a great option to change loan terms https://paydayloansohio.net/cities/bucyrus/ and pull money out of your home. However, for borrowers considering the VA cash-out refinance program, it’s important to understand some key differences between different loan types. As such, we’ll use this article to explain the VA’s type 1 vs type 2 cash-out refinance.

  • What Is a Cash-out Refinance?
  • Overview of the VA Cash-out Refinance Program
  • Type 1 Cash-out Refinance
  • Type 2 Cash-out Refinance
  • Applying for a VA Cash-out Refinance Loan
  • Final Thoughts

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What Is a Cash-out Refinance?

As the name suggests, a cash-out refinance allows borrowers to take out a new mortgage, pocketing the difference between the new and old loans as cash. More precisely, the new loan pays off the balance of the current mortgage. The remaining balance of the new mortgage then goes to the borrower as cash.

The cash-out loan process hinges on the concept of equity. A borrower’s equity – or ownership – in a home equals the current home value minus the outstanding mortgage. For example, if your home is worth $400,000 and you have a $250,000 mortgage, you have $150,000 in equity ($400,000 value – $250,000 mortgage). Cash-out refinances allow you to convert this equity into cash. And, lenders issue these loans based on three related factors: 1) current home value; 2) outstanding mortgage; 3) loan-to-value (LTV) ratio.

Assume a lender offers a cash-out refinance up to 90% LTV. Using the above numbers, that means the borrower would qualify for a $360,000 cash-out refinance loan ($400,000 value x 90% LTV). However, before paying out cash, the lender must pay off the outstanding mortgage balance. This means the borrower could receive $110,000 in cash from this property – excluding closing costs ($360,000 cash-out refinance loan maximum – $250,000 current mortgage balance).

Why Do a Cash-Out Refinance?

While not all-inclusive, here are some common reasons why people would want to take cash out of their homes via a loan refinance:

  • Consolidate debt: If you have thousands of dollars in debt – or more – on credit cards, student loans, or auto loans, you’re likely paying far higher rates than you would on a home mortgage. As a result, many people take the money from a cash-out refinance to pay off other, higher interest debt. This A) reduces interest payments, and B) consolidates debt into a single mortgage payment – administratively easier.
  • Finance a large purchase: If you want to add a living room to your house or put together a down payment for an investment property, you may not have enough cash on-hand. A cash-out refinance provides a means to access money at a low rate and long repayment period to use for these large purchases.
  • Pay for a financial emergency: Unfortunately, medical, legal, business, and family emergencies can come out of nowhere. And, most of these emergencies also come with large bills. Rather than dipping into retirement savings or maxing out a credit card, a cash-out refinance can provide you the cash you need to address these financial emergencies.

Overview of the VA Cash-out Refinance Program

While most borrowers researching a VA cash-out refinance inherently understand how VA loans work, this isn’t always the case. More precisely, the VA cash-out refinance program is the only program that allows eligible veterans with a conventional mortgage to refinance that mortgage into the VA program. As a result, some veterans considering this refinance program may have never used a VA loan before, so we’ll begin with a brief overview of how VA loans work.

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