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A "cash-in" refinance allows a homeowner to replace their existing mortgage while making a lump-sum payment that enables them to get more favorable borrowing terms on the new loan. This type of refinance can be a viable option if you've recently received a cash windfall (via an inheritance, tax return, lottery winnings, etc.) and want to change the terms of your existing mortgage.
In market climates with falling interest rates, pursuing a cash-in refinance can be a good way for any mortgage borrower to secure a lower mortgage interest rate. Here's a rundown on how cash-in refinance mortgages work, and factors to consider when deciding if one is right for you.
How Does a Cash-in Refinance Work?
A cash-in refinance is, first and foremost, a form of refinancing— replacing your current mortgage with a new loan. In a refinance, you borrow a sum equal to what you owe on your existing mortgage, pay off that loan and then pay off the new loan in a series of monthly installments.
The process of applying for a refinance loan is basically the same as the one required for obtaining your original mortgage. The lender will require:
- A credit check: Every lender has its own lending standards, but a minimum FICO® Score☉ of 620 is typically required for a mortgage. Many lenders prefer higher scores, and the best rates are typically reserved for borrowers with scores of 760 or higher.
- Proof of income: This is usually in the form of pay stubs, tax returns or bank records showing direct paycheck deposits.
- Records of your monthly expenses and debt obligations: These will be used in calculating your debt-to-income (DTI) ratio—the percentage of your monthly pretax income devoted to debt payments. Lenders view DTI ratio as an important measure of your ability to cover your loan payments, and typically prefer DTI ratios of 36% or less. Government-backed loans allow DTI ratios as high as 43% and a DTI as high as 50% may be acceptable if you have sufficient assets or other "compensating factors."
The "cash-in" component of the loan application is comparable to the down payment you made on your original mortgage. Paying a lump sum reduces the size of your new loan and, ultimately, will likely decrease your monthly payments when compared with what you're paying on your current mortgage. Contrast this with the similar "cash-out" refinance where you refinance with a new, larger loan and pocket the difference between it and your existing mortgage.
As with an original purchase mortgage, the lender will use your credit and financial information to determine the loan amount they are willing to offer you, and the interest rates and fees they'll charge on the loan. If your credit and income are as good as or better than when you applied for your original mortgage, you're unlikely to have problems qualifying for a refinance loan, especially if you're bringing additional cash to the table.
What Are the Pros and Cons of a Cash-in Refinance?
A cash-in refinance can be a good idea if you've got extra money you can throw at your mortgage, but it isn't without its drawbacks.
Pros of a Cash-in Refinance
Depending on your current circumstances, a cash-in refinance can offer several potential benefits. A cash-in refinance loan can enable you to:
- Convert from an adjustable-rate mortgage (ARM) to one with a lower fixed rate
- Remove private mortgage insurance (PMI) premiums from your monthly mortgage payments
- Otherwise lower monthly payments and reduce overall borrowing costs
- Lower the number of payments you must make before you pay off your home loan in full (if you qualify for, say, a 15-year mortgage instead of a 30-year mortgage)
Cons of a Cash-in Refinance
On the other side of the coin, cash-in refinances do have their drawbacks, including:
- A higher interest rate if you took out your original mortgage loan at a lower interest rate
- Additional fees that come with taking out a new loan, including application fees, origination fees and appraisal fees
- Loss of the potential earnings or other advantages of using the "cash-in" funds in another way, such as padding out your emergency fund or investing in retirement
Alternatives to Cash-in Refinancing
If you have an existing mortgage and a significant new source of cash to put toward your home, a cash-in refinance is not your only option. Here are some other strategies to consider:
Make a Lump-Sum Principal Payment
If you've got extra money in the bank but you don't want to pursue a cash-in refinance, you can put that money toward the principal on your current mortgage.
A payment against principal can reduce the number of payments you have to make over the life of the loan and lower the amount of interest you pay over time.
Before going this route, make sure your mortgage contract doesn't include a prepayment penalty. While relatively rare in current loans, lenders sometimes stipulate these charges be paid to offset the loss of interest payments they receive if you pay off your loan ahead of schedule.
Recast Your Existing Mortgage
If you have a conventional mortgage and a low fixed interest rate, you may accomplish many of the same goals as a cash-in refi at lower overall cost by asking your lender to recast your existing mortgage rather than refinancing with a new one.
When a loan is recast, it retains its original interest rate and repayment term, but applying your lump sum payment against the principal of the loan can enable:
- Elimination of PMI premiums, if your payment increases your total home equity to 20% or more of the loan amount.
- Additional reduction of monthly payments, based on recalculation of the amount you owe after making your lump payment and the number of payments remaining on the loan.
Recasting your loan instead of refinancing helps you avoid closing costs (although you may have to pay an administrative fee of a few hundred dollars).
Recasting generally will not allow you to reduce the number of payments remaining on the loan, but if you want to repay the loan faster you can consider making extra payments over the course of each year. For example, if you submit a payment equal to half of your standard monthly mortgage installment every two weeks, you can end up making 13 full payments annually instead of 12, which can help you reach the end of your mortgage term sooner (and lower total borrowing costs over the life of the loan).
Is a Cash-in Refinance Right For You?
In the current climate of rising interest rates, refinance mortgages of all kinds, including cash-in refinances, are losing their appeal among borrowers with fixed-rate loans.
If you have a current mortgage with a fixed interest rate you may have difficulty improving on that rate, even if you have a sizable sum to put down on a new loan. In that case, it probably makes sense to apply your extra funds toward the principal on your loan or try recasting your loan. Depending on the amount of your lump-sum payment, these options could save you thousands (or even tens of thousands) of dollars over the life of the loan.
A cash-in refinance could make sense for you if you have access to a sizable sum and your current loan has an adjustable interest rate and you can qualify to convert to a fixed-rate loan.
If you choose this option, be sure to compare total costs of any new loan with projected lifetime costs of your existing loan before deciding which option is better for you. (If you have an ARM, consult with a loan officer or a real estate professional for the best way to project its total cost; it may make sense to use the loan's lifetime-capped interest rate for comparison purposes.)
The Bottom Line
Rising interest rates make mortgage refinances of all kinds, including cash-in refinances, less advantageous than they were just a few years ago. But under the right circumstances, refinancing your existing mortgage with an additional lump-sum payment can gain you more favorable borrowing terms and save you money over the life of your loan.
If you're considering applying for a refinance loan (or any mortgage), it's wise to check your free credit report from Experian and your credit score beforehand to get an idea of how lenders will view your creditworthiness. If it makes sense to do so, consider taking a few months to spruce up your credit before applying for the loan to give yourself the best chances of approval.