If you want to refinance your mortgage but the closing costs involved would break your budget, a "low-cash-out" refinance may be right for you. If you've got some equity in your home, this option allows you to eliminate paying the closing costs upfront by rolling your refinancing costs into your new loan.
Most homeowners are taking advantage of today's low mortgage rates by opting for a traditional refinance -- sometimes without even considering the other refinancing options. While a traditional refinance will save you more money over the long term, a low-cash-out refinance (also known as a limited-cash-out refinance) can help you keep your assets more liquid in the short-term, leaving you money to spend or invest.
How a low-cash-out refinance can put cash in your pocket now
The biggest advantage of the low-cash-out refi is that you don't have to pay all of the closing costs up front -- any costs not covered at closing are tacked onto the remaining loan balance, and can be paid over time. For those who have more immediate uses for their money or who don't have enough savings, this may be your only option.
Since this type of financing strategy doesn't limit you to the amount of available cash you have to have on hand, you may even be able to pay extra fees to get a below-market mortgage rate and pay for it over time. It's also possible to get some cash back without being subject to the extra fees and stricter underwriting standards associated with "cash-out" refinancing. Most mortgage lender guidelines allow you to receive up to 2 percent of the loan amount or $2,000 (whichever is less) in cash back.
Lower costs now may lead to higher costs tomorrow
The chief disadvantage of a low-cash-out refi is that you'll need extra home equity to roll your costs into the new loan. In today's environment of falling home prices, not only will you need to retain a fairly large equity stake after your transaction is closed, you'll need enough to cover the fees, too -- and many folks have a lot less equity than they did when they bought their home or last refinanced.
If your loan today does not require mortgage insurance, the last thing you want to do is raise your loan-to-value (LTV) to the point that you need it. In addition, raising your LTV can make refinancing more expensive. A look at Fannie Mae's Loan Level Pricing Adjustment Matrix shows that someone with a 680 credit score and an LTV of 75.01 percent pays .5 percent more in fees than a borrower with a 75 percent LTV.
It's good to note that the extent to which rolling costs into your loan will affect your mortgage pricing. Your price will depend on your LTV and credit rating, and higher LTVs won't always cost you more.
Once you decide you're going to refinance, you must decide how you're going to pay for it. HSH's Tri-RefiTM refinance calculator can help you decide which financing strategy is best for you (whether that's a Traditional, Low-cash-out or a Cash-out refinance). Input your mortgage parameters and calculate how much each option will cost or save you over time.
