What Is A Limited Cash-Out Refinance And How Does It Work?

While being a homeowner is expensive, tools exist to help borrowers afford their home. Refinancing is an option that may help homeowners navigate hard financial situations without losing their home.

If you’re trying to make ends meet and have a high interest rate on your mortgage, a limited cash-out refinance can provide some cash relief and help you save money on interest or your loan term.

What Does ‘Limited Cash-Out Refinance’ Mean?

A limited cash-out refinance replaces your existing mortgage with a new mortgage with better terms. The new loan is often a higher amount to help cover closing costs.

With a limited cash-out refinance, you can pocket $2,000 or 2% of the new loan balance, whichever is less. However, the new loan balance will be higher than the original because of the funds disbursed and any closing costs rolled into the new loan.

Limited Cash-Out Refinance Vs. No Cash-Out Refinance

As the name implies, a no cash-out refinance doesn’t allow the borrower to walk away from closing a new loan with extra cash. Instead, it’s a rate-and-term refinance, meaning the borrower refinanced to get a better interest rate or loan term, or to work with a different lender.

Additionally, you typically don’t roll closing costs into the new balance with a no cash-out refinance. Therefore, a borrower can get a new loan with an identical amount or lower amount than before.

Limited Cash-Out Refinance Vs. Cash-Out Refinance

A cash-out refinance does not have the limitations of the other refinancing options listed above. A borrower with a large chunk of their mortgage paid off could receive tens of thousands of dollars from a cash-out refinance. The maximum a cash-out refinance could provide on conventional loans is usually 80% of your home’s value.

This option differs from the other two types of mortgage refinances. No cash-out refinances give the borrower better terms and rates but no direct money. Limited cash-out refinances also allow borrowers to get better terms and provide the borrower with a bit of money, typically $2,000.

Limited Cash-Out Refinance Vs. Other Cash-Out Refi Types

There are plenty of refinancing options available for borrowers in different situations. However, refinancing is not a one-size-fits-all solution, so it pays to research before you get yourself into a refi that doesn’t work for you.

• FHA cash-out refinance: This type of refinance is insured by the Federal Housing Administration (FHA) and may have a reduced interest rate compared to conventional loans. However, the borrower must pay mortgage insurance for the life of the loan.
• VA cash-out refinance: The Department of Veterans Affairs (VA) can back cash-out refinances for qualifying veterans, active duty military, Reserve/National Guard members, and surviving spouses. Borrowers can receive up to 100% of their home’s value to consolidate higher-interest debt, meet other expenses or change their mortgage into a VA loan.
• Cash-in refinance: This type of refinance allows you to make a lump sum payment toward your home loan during the refinance to increase equity in your home and have a smaller principal balance. A cash-in refinance may be useful if you have an underwater mortgage or want to qualify for a lower rate because of increased equity in your home.
• FHA Streamline refinances: This option is a swift method of refinancing that allows you to lower your interest rate and reduce your monthly payment with an existing FHA loan, but you must pay reduced closing costs and mortgage insurance.
• VA Streamline refinances: These refinances allow military members and surviving spouses to rapidly secure a new VA loan that provides an instant improvement, such as a smaller monthly payment or reduced interest rate.
• No-closing-cost refinance: With this type of refinance, no closing costs are required upfront or at closing. To cover closing costs, borrowers could have a higher monthly payment, steeper interest rate or both with a no-closing-cost refinance.
• Short refinances: Borrowers receive a decreased mortgage balance and monthly payment to help them stay in their home after defaulting on their mortgage.

How Much Does A Limited Cash-Out Refinance Cost?

You will need to include closing costs when you are planning to refinance. Typically, closing costs are about 2% – 6% of the balance on your existing mortgage when refinancing. You won’t need to pay the money upfront, as it can be added to your new loan balance. However, your loan balance will increase due to closing costs, causing you to pay more over time in interest.

Requirements For A Limited Cash-Out Refinance

All lenders have refinance requirements for borrowers who want to restructure their mortgage. Generally, the requirements for a limited cash-out refinance are slightly more lenient than a traditional cash-out refinance. Here are three main factors Fannie Mae uses to determine eligibility for a limited cash-out refinance.

Loan-To-Value Ratio (LTV)

To refinance, you need a certain amount of equity in your home. In other words, if you haven’t paid off enough of your existing mortgage, you might not be eligible for a refinance. Conventional loans usually require a loan-to-value ratio (LTV) of 97% or lower, meaning the loan size will be 97% of your home’s appraised value or less. Therefore, you most likely won’t have to pay down a significant portion of your mortgage to qualify for a limited cash-out refinance.

Debt-To-Income Ratio (DTI)

Lenders calculate this figure by dividing the sum of your required minimum monthly debt payments by your monthly pretax (or gross) income. Debts such as your mortgage payment, property taxes, homeowners insurance, student loans and credit card debt contribute to your debt-to-income ratio (DTI). The ratio tells your lender if a borrower can afford the monthly payment of the new mortgage.

Credit Score

The better your credit score, the easier it is to secure a new loan and obtain a better interest rate. Borrowers should aim for a credit score of 620 or higher to be eligible for refinancing a conventional loan.

Pros And Cons Of A Limited Cash-Out Refinance

As with any financial tool, there are advantages and disadvantages to using a limited cash-out refinance, as outlined below.

Pros

• Closing costs can be rolled into the new loan amount and don’t need to be paid upfront.
• The borrower comes out of the process with up to $2,000 to use as they wish.
• To be eligible, little equity is needed; buyers with almost no equity can qualify.
• Borrowers may be able to secure a better interest rate or loan term.

Cons

• Borrowers come out of the process with a slightly higher loan amount.
• The maximum cash-out for this transaction is $2,000, so a traditional cash-out refinance might be better for borrowers with more equity and heftier expenses.
• The refinance can’t go through if your home is for sale.

When To Choose A Limited Cash-Out Refinance

Let’s say a homeowner has $150,000 left on their mortgage for their home that appraises for $180,000. The homeowner learns they can refinance the home and lower their interest rate. The homeowner also has a minor home improvement project that will cost about $2,000 but is having trouble finding the money for it.

In this case, a limited cash-out refinance is a better option than a no cash-out refinance because the homeowner is fielding a $2,000 expense. A limited cash-out refinance allows the borrower to accomplish two goals at once: securing a better interest rate and providing a bit of cash to improve the house.

In addition, since the closing costs will be rolled into the new loan amount, the borrower doesn’t have to pay upfront for the refinance, instead pocketing up to $2,000 and paying a lower interest rate. The borrower does take on a higher loan balance but has decided that the pros outweigh the cons because of the lower interest rate and immediate cash benefit.

The Bottom Line

A limited cash-out refinance makes the most sense for a borrower with a low amount of equity in their home and a pressing need for around $2,000. Thinking of refinancing your home? Begin the application process today with Rocket Mortgage^®.