You’ve likely heard of a cash-out refinance where you tap into your home’s equity. But what is a limited cash-out refinance?
The limited cash-out loan allows you to take a small amount of cash out of your home’s equity, but not as much as the cash-out refi. The limited cash-out refi is often known as the rate/term refinance. Your main goal is to get a lower interest rate and/or payment. As a bonus, you may be able to take a little bit of the equity out of your home.
What Are the Limits of the Limited Cash-Out Refinance?
Most loan programs, including conventional loans, allow you to take a maximum of $2,000 or 2% of your loan amount, whichever is less. This is in addition to the money you can roll into the loan amount for closing costs. Of course, all of this is limited by the fact that your home is worth enough. Without a high enough home value, you cannot take any cash out of the home.
Here’s an example. Your home is worth $250,000. You have a $200,000 outstanding mortgage that you want to refinance to get the lower interest rate. You also have $5,000 in closing costs you want to roll into the loan. You have a $205,000 loan. If you wanted, you could also add the $2,000 limit to have a loan amount of $7,000 and take the $2,000 in cash at the closing.
When You Can’t Use the Limited Cash Out Option
The limited cash-out refinance has its benefits. It generally has a lower interest rate than the cash-out refinance because there’s a lower level of risk. The lender isn’t giving you a loan that is that much higher than your current loan. Assuming you have good credit and a good debt ratio, the lender may not feel this is a high-risk loan.
But, there’s a catch. If you have more than one mortgage on your home and you plan to combine them into one loan, you cannot use the limited cash-out refi option. Because you are paying off a second mortgage, it automatically becomes a cash-out refinance. The only way around this rule would be to keep the second mortgage and ask the mortgage company that holds your second mortgage to subordinate the loan.
When a mortgage company subordinates the loan, it means they agree to take a subordinate or second position. This is where second mortgage companies start off, so it’s usually not a big deal. But, if you are a risky borrower, the mortgage company may not be willing to subordinate, which could risk your ability to refinance.
What’s the Point of the Limited Cash-Out Refinance?
The main goal for a limited cash-out refinance is to get a lower mortgage payment and/or mortgage rate. If you decide you need a little cash from the home’s equity, you can do so. If you take out a mortgage beyond $100,000, the most you can take out is $2,000. That $2,000 might help you with a specific expense or give you a little bit of an emergency fund. It’s not so much that it will excessively increase your mortgage balance or your mortgage payment, though, so it’s often a good choice for borrowers.
Before you take any equity out of your home, even just $2,000, you should be careful. Think about what you need the money for and if it’s worth taking it out of the investment in your home. Your payment shouldn’t drastically increase and your rate might not be very affected, but make sure you explore all of your options and know how the loan will affect your bottom line.