In the past month there has been a drop off in requests for purchase mortgages and an increase in requests for cash-out refinance mortgages. A large number of applications are from homeowners that desire to get the maximum cash they can be approved for, and place it in a bank account as an emergency fund for the duration of the Covid-19 virus and its economic aftermath. These homeowners have no desire to use any of the funds and hope to be able to pay down their mortgages at a later date. The emergency fund is intended only as a source of liquidity in the event of unemployment or illness.
For those contemplating creating such an emergency fund from cash-out refinances, here are some things to consider:
- Employment. Be sure you are employed when you close the refinance mortgage. Most lenders are now requiring proof of employment as soon as one day prior to loan closing. Unemployed borrowers will not be approved for the mortgage, unless they have a separate source of income. Self-employed borrowers must show a steady income stream currently, and as far back as two years, and they are being looked at closely.
- Adjustable Rate Mortgages. Consider getting an adjustable rate mortgage (ARM). The reason for this is that prepayment of mortgages is treated differently for fixed rate mortgages than for ARMs. For a fixed rate mortgage, prepayment amounts are applied to the final mortgage installments in reverse order. ( Eg. 360,359,358, etc.) This shortens the term of your mortgage but not the monthly mortgage amount. That is why these prepayments are called “curtailments”.
For an ARM, prepayments not only reduce the loan amount but cause a recasting of the monthly mortgage payment. So, you immediately show a reduction of your monthly payment.
( But not a shorter term of mortgage.) And, of course, there is the risk of rising interest rates in the future. ( Or, lower rates.)
If an emergency fund is in your plans, it is recommended that you implement it earlier than later. Rates have returned to very good levels, thanks to the actions of the Federal Reserve and the Government National Mortgage Association. Remember, the maximum loan-to-value for cash-out mortgages is 80%. You must have more than 20% free equity in your home to realize any cash out ability.