When a cash-in refinance makes sense for you

A cash-in refinance is when you replace your current mortgage with a smaller one after making a lump-sum payment. It is a good option when you come into a large amount of money, such as from an inheritance, a tax return, or a work bonus.

When refinancing your mortgage, putting more cash in can have major benefits. Not only can it lower your monthly payment, but it can also help you save money on interest. But a cash-in refinance is not for everyone. That’s why it is important to weigh your options.

In this article, we will define cash-in refinance, outline the pros and cons, and offer alternatives. Here is everything you need to know about cash-in refinance. 

What is the meaning of cash-in refinance?

A cash-in refinance is a form of refinancing where you, as the homeowner, make a lump-sum payment on your mortgage during the refinancing process. The result is that you would replace your current home loan with a loan that has a smaller principal balance.

You can think of a cash-in refinance like a mortgage recast. This is when a mortgage lender agrees to make changes to the terms of the home loan after the borrower has made a lump-sum payment.

The difference between the two, however, is that with a mortgage recast, you would keep your current mortgage term and mortgage rate. A mortgage recast also means your mortgage lender will accept your cash payment and apply it to your principal balance.

What is the difference between a cash-in and cash-out refinance?

Simply put, a cash-in refinance is the opposite of a cash-out refinance. With a cash-in refinance, you are placing more equity into your home. In a cash-out refinance, on the other hand, you are converting existing home equity into cash.

Find out which is a better option, cash-out refinance vs home equity loan? Read more here.

The cash you receive from a cash-out refinance is often used for significant expenses like home improvements, debt consolidation or to shore up your retirement account. In exchange for that lump sum, you are taking on a larger mortgage balance.

Not everything is different, however. In both cash-in and cash-out refinance, your existing home loan is being paid off and you are taking on a new mortgage with different terms. Most homeowners take advantage of the chance to refinance when interest rates are low.

How does cash-in refinance work?

A cash-in refinance is replacing your current mortgage with a new home loan. When refinancing, you borrow a sum of money that is equal to what you owe on your existing home loan, pay off that mortgage, and then repay the new loan through monthly payments.

To apply for a refinance, you essentially follow the same steps as you did for obtaining your initial mortgage. Your mortgage lender will require the following:

• Credit check: All lenders have their own lending standards. However, a FICO Score of 620 minimum is usually required for a home loan. Most lenders prefer higher credit scores, and the best mortgage rates are often reserved for borrowers with a credit score of at least 760.
• Proof of income: Proof of income typically comes in the form of tax returns, pay stubs, or bank records that show direct paycheck deposits.
• Monthly expenses/debt obligations: Records of both monthly expenses and debt obligations are used to calculate your debt-to-income (DTI) ratio. Your DTI is the percentage of your monthly pre-tax income set aside for debt payments. Mortgage lenders see DTI ratio as a reliable measure of your ability to make your mortgage payments. Typically, lenders want a DTI ratio of 36% or less. Government-backed loans allow for DTI ratios up to 43%. And if you have sufficient assets or other compensating factors, a DTI as high as 50% might be acceptable.

The cash-in component of the loan application is like the down payment you had to make on your initial mortgage. By paying a lump sum, you reduce the size of your new loan. This means that, ultimately, you will likely decrease your monthly payment compared to what you are currently paying. By contrast, with a cash-out refinance, you refinance with a larger loan and receive the difference between it and your existing loan.

Like with your initial mortgage, your lender will use your financial and credit information to determine the loan amount they will offer you. They will also determine the fees and interest rate you will be charged on the loan.

You are unlikely to encounter any issues qualifying for your refinance if your income and credit are as good or better than when you applied for your original mortgage. It will also be considerably easier if you bring additional cash to the table.

What are the pros and cons of cash-in refinance?

There are numerous reasons that you may consider a cash-in refinance, which include qualifying for better loan terms and reducing your monthly payment.

Cash-in refinance: the pros

Let’s take a quick look at the pros of cash-in refinance:

• Lower monthly payments
• Lower LTV
• Shorten/lengthen loan term
• Go from ARM to fixed rate
• Eliminate mortgage insurance

Here is a closer look at the pros of cash-in refinance.

Lower monthly payments

Cash-in refinance involves putting equity into your home. This means you are lowering your mortgage balance. If you keep the same term, you will usually have lower monthly payments, if interest rates have not significantly increased.

Lower LTV

Increasing your equity in a cash-in refinance also lowers your loan-to-value ratio, or LTV. This will increase your flexibility to refinance going forward. LTV is like the inverse of equity. For instance, if you have 20% equity in your home, your LTV would be 80%.

LTV is critical since most major loan options (outside of VA loans) require that you have 20% equity in your home minimum, after the refinance, to take out cash. You are not looking to take cash out in a cash-in refinance, but you may want the option in the future by making a large payment now.

Shorten/lengthen loan term

A cash-out refinance also allows you to shorten or lengthen your loan term. If you shorten your term, you get a lower rate versus loans that have longer terms since investors do not have to project inflation as far out. And by paying off your new mortgage faster, you also save thousands on interest.

Opting for a longer-term mortgage, on the other hand, means you have the chance to have lower monthly payments. Since inflation is being projected further, the trade-off becomes a higher interest rate. And by taking longer to repay the mortgage, you end up paying more in interest. It is a good option, however, if you need the funds to put into your home for other things.

Go from ARM to fixed rate

ARM, or adjustable-rate mortgages, have lower interest rates compared to current market rates since investors are not forced to guess where inflation is going to be. After the initial fixed period, the interest rate can always adjust up or down.

You should, however, consider a fixed-rate mortgage if you stay in your home longer or if interest rates are trending up around the time of your adjustment. Fixed-rate mortgages give you payment certainty for the entire loan term. In this scenario, a cash-in refinance makes sense.

Avoid mortgage insurance

By doing a cash-in refinance, you can increase your home equity to at least 20%, which is usually the minimum down payment you must make to avoid mortgage insurance. If you refinance into a conventional loan, you can avoid mortgage insurance payments on your home in the future, if it is a primary property.

Cash-in refinance: the cons

While there are numerous benefits with a cash-in refinance, it is not always the best choice for everyone. One disadvantage of a cash-in refinance is that it can be costly. It is therefore crucial to ensure that the benefits outweigh the costs.

Let’s take a quick look at the cons of a cash-in refinance:

• Costs
• Lost liquidity

Here is a closer look at the cons of a cash-in refinance.

Costs

There are costs in the form of refinancing fees that come with setting up your loan. While they can be less costly than on the purchase, you can expect to pay between 2% and 6% of the loan amount in closing costs. Common costs necessary to refinance might be the title search, the appraisal, and the lender’s title insurance. Reminder: do the math to see if the benefits of a cost-in refinance outweigh the costs of refinancing.

Lost liquidity

If you earned a work bonus, received an inheritance, or have come into a significant amount of money another way, it’s a good idea to prioritize your emergency funds.  When putting money into your property, you must refinance to get it back out again. This takes not only money but time. You may want to put your money toward more liquid assets that can be more easily converted into cash.

Cash-in refinance: closing thoughts

When determining whether to do a cash-in refinance, it is important to understand the potential benefits as well as the potential costs. You may be able to lower your monthly costs and avoid mortgage insurance payments. However, you also risk losing liquidity.

Remember: the more knowledge you have, the better off you will be.

For help determining if a cash-in refinance will work for you, get in touch with one of the mortgage professionals we highlight in our Best of Mortgage section. Here you will find the top performing mortgage professionals across the USA.

Did you find these tips useful? Do you have experience with a cash-in refinance? Let us know in the comment section below.