There’s one thing most borrowers worry about when getting a new mortgage – the interest rate. So it’s no wonder people worry about the interest rate when taking a cash out refinance. The talk is that rates are higher with this type of loan; is it true?
Unfortunately, the rumor is true. You will likely pay more interest when you take cash out of the equity of your home. Lenders base the interest rate they charge you on the riskiness of your loan. Taking a larger loan than you already have is considered risky, so it makes sense that a lender may charge you a higher rate.
However, it does depend on many other factors, which we discuss below.
The Overall Riskiness of Your Loan
We already discussed the riskiness that a cash out refinance causes a lender. They lend you more money than you already borrowed – that’s a risk.
But, what does the rest of your profile look like? Do you pose a risk for other factors? Consider things like:
- What’s your credit score?
- How much debt do you have compared to your income?
- Do you have a lot of late payments on your credit history?
- How long have you had your current loan?
- What’s your payment history like on your current mortgage?
- How many assets do you have on hand?
These are things the lender will evaluate. The lower your credit score and the higher your debt ratio, the more risk you pose. If you have a lot of late payments on your credit report, you are again a high risk. It’s even worse if you have late mortgage payments reporting.
The more positive factors you can give a lender, the fewer adjustments they will make to your interest rate when you take cash out of your home’s equity.
What’s Your Loan-to-Value-Ratio?
This is another big factor. The higher your LTV, the higher the riskiness of your loan. Most programs don’t allow borrowers to take more than 80% of their home’s value in a cash out refinance. But, the closer you are to that number, the less likely it is that you’ll get a low interest rate.
Here’s how a lender looks at it. The higher your loan-to-value ratio, the harder it will be for the lender to get their money back if you default on the loan. Let’s say you have the full 80% allowed amount outstanding and you default on the loan. Chances are that the lender is not going to get the full amount for your home as they sell it as a foreclosure. They will get a percentage of it, leaving the bank with a pretty serious loss.
If, however, you only borrowed 50% of the value, the bank has a much better chance of getting the full amount of the money they loaned to you back by selling it as a foreclosure. In this case, your risk level is lower, which may mean a lower interest rate.
What’s Your Reason?
The final factor in determining your interest rate on a cash out refinance is why you need it. Are you investing back in your home? Are you consolidating debt? Or do you have a personal reason for needing the money? This will play a role.
If you invest the money back into your home, the lender won’t look at it as very risky. You potentially make the bank more money by raising the value of your home. That’s the least risky thing you can do with the money. If you are consolidating debt, you might be a little riskier. While it’s a good thing that you are wrapping up your debt and trying to get rid of it, there’s still a bit of risk the lender takes. Of course, if your reasons are personal, the lender will look at this situation as the riskiest.
How a lender reacts to your need for a cash out refinance depends on many factors. Some lenders don’t charge higher interest rates just because you need cash out while others greatly inflate the rate. Your best bet is to shop around and see what different lenders have to offer. This way you can get the lowest rate available to you.