Your lender called and told you that your refinance was a cash out loan and your rate will be a little higher than originally quoted. But you laughed. “I’m just refinancing my current mortgage and not taking cash out at all, so you can just crawl back in that hole you came out of. Nice try, though.” But your lender didn’t laugh. Your lender was right.

Recent changes in mortgage lending have made some loans pricier because of their loan status. “Cash out” loans, or mortgage loans that are refinanced while at the same time pulling a little equity out in the form of cash proceeds to the borrower, carry a higher risk than an identical loan that pulls zero cash back. Most of these cash out loans carry an extra premium if the loan balance exceeds 75% of the value of the home.

But the surprise comes for those who carry second mortgage balances. Second mortgages can be in the form of a home improvement loan, an equity loan or a HELOC, or Home Equity Line of Credit. Any second mortgage that is being considered during a refinance that was not part of the original purchase transaction, for pricing purposes, must carry the tag “cash out.” Remember, loans that have taken cash out from their equity carry a slightly higher default rate than those who do not. It makes no difference if the cash was taken out during a single refinance or the cash was taken out later after the purchase.

For instance, you bought a home for $100,000 five years ago. Three years ago you took out a second mortgage to pay off a car and remodel your kitchen. This year you decided to refinance both mortgages into one. Your lender will consider this a cash out loan, and if your new loan balance exceeds 75% of the value of the home then you can expect a slight increase in rate or fee.

But what if you’re not refinancing two loans together, what if you’re keeping your second loan where it is by subordinating it to your new first. In this instance, lenders look at your Total Loan to Value (TLTV). If your total loan to value exceeds 90% of the value of your home, your lender may not approve the loan as structured. Your option may only be to pay down the balances of the loan or not refinance at all.

Another surprise might come from your HELOC. For purposes of calculating TLTV it’s not the current balance on equity that second but the actual equity line limit that is used. If your first mortgage is $100,000 and you have an equity line of $50,000 with a zero balance on it, your lender may in fact use the limit, not the balance when determining TLTV. If your TLTV is above 75%, then you can anticipate an additional charge from your lender.

Equity loans, home improvement loans and HELOCs are not bad things, they’re great as they allow you to tap into existing equity to do with what you please. Just realize going into the game that the presence of a second mortgage may impact your closing costs when you go to settlement. That’s indeed when a “no cash out” loan becomes a “cash out.” Don’t be surprised.

Published: August 22, 2003

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