Is it Better to Refinance Your Mortgage & Consolidate Bills or Refinance & Cash Out?
Whenever a homeowner chooses to take money out of his home's equity, the lender usually considers this a cash-out refinance. Even if the borrower never actually receives the money but the lender uses the funds to pay off other debts, it is still a cash-out refinance. Only the homeowner can decide if it's better to consolidate the bills into the new mortgage or to simply receive cash out.
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Cash-Out Refinance Basics
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The most common cash-out refinance programs are underwritten to guidelines set by Fannie Mae or Freddie Mac. Any time the borrower receives more than the lesser of 2 percent or $2,000 when a mortgage closes, Fannie Mae and Freddie Mac consider this cash-out refinance. The borrower may request the title company pay off other debts with the funds or personally pay off the debts. Homeowners obtaining a cash-out refinance should expect stricter qualification requirements, higher interest rates and a lower maximum loan amount than if they obtained a rate and term refinance.
Consolidating Bills
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Homeowners should remember when they consolidate bills, they are not really paid off. They are simply financing them into their mortgage, usually over 30 years. While this may lower the overall payment required to pay the debt, the debts do not go away, they are just transferred into the mortgage. One advantage of consolidating all of the bills into a mortgage is the tax deductability of the interest. Most car loans and credit cards do not allow a homeowner to deduct the interest on their tax returns. In many cases, the bowers may deduct mortgage interest on their tax returns. Additionally, consolidating bills usually provides a lower overall monthly payment.
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Receiving the Cash
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If the borrowers choose to receive the cash personally, they then must have the discipline to pay off the debts. When the homeowners receive the funds, the mortgage company does not require the homeowner do anything with the funds. The homeowners may put them in savings, spend them on a vacation, make improvements to the home, pay down their debts or anything else they choose. Some homeowners may receive tens of thousands of dollars from their cash out refinance; only they know the best way to spend the money. If the borrowers have significant debt, they may wish to use some of these funds to pay off the debt and use the rest however they choose.
Lender Requirements
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Sometimes lenders require the homeowners pay off a certain debt to qualify for a mortgage. Lenders compare the minimum required payments of all the debts plus the new mortgage payment to the borrower's gross monthly income. This is called the Debt to Income ratio. Most loan programs require the borrowers' DTI ratio not exceed specific thresholds. If the borrowers' DTI does exceed certain thresholds, the lender may require the borrower pay off some debt at closing to qualify.
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