A house that is owned free and clear can still be refinanced. Doing so is called a cash-out refinance. In a traditional cash-out refinance, an existing mortgage is paid off with a larger mortgage, resulting in a lump sum of cash to the owner. If there is no mortgage on the property at present, the same basic loan structure and regulations would apply. One of the steps the lender has to take in this scenario is to determine a tangible benefit in the homeowner pulling cash out of his home. The reason for refinancing -- whether for home improvement, investment, tuition, or other purposes -- must be documented for the loan file.
If you're taking out a mortgage on a house that has been paid off, the lender will probably require a debt-to-income ratio less than 43 percent. This means that your total monthly debt payments can't be more than 43 percent of your monthly gross income. Some large lenders may not follow this requirement if they think you have the ability to pay the loan.
Home Equity Loans and Lines of Credit
Depending on your financial needs, a home equity loan or line of credit may be a good option. These loans typically have no closing costs other than an appraisal. Rates are higher than for a standard mortgage, or are variable. But if your needs for the cash are short-term, you'll save money by avoiding closing costs.
One of the advantages to carrying a mortgage on your primary residence is that the interest is tax-deductible. But if you take cash out on a home you own free and clear, there will be some restrictions on deducting the mortgage interest. The interest on the first $100,000 should be tax-deductible in all cases. Any excess amount may be tax-deductible depending on the purpose. If it's for home improvement, it should all be tax-deductible. But if it's for investment or other purposes, it may not be. If this is a factor in determining whether it would be beneficial for you to take out a mortgage, talk to your tax adviser before finalizing the loan paperwork.
First Year of Ownership
If you buy a house with cash in order to hasten the closing process, and want to cover your investment with a mortgage later, this will be difficult to accomplish within the first year of owning the house. This is often the strategy of investors buying foreclosed or otherwise distressed properties at auction. If you plan to reside in the house, you may be able to get a mortgage right away, but if you're renting it, plan to wait at least six months, and probably a year, before obtaining financing.
- House Logic: Tax Deductions for Homeowners: How the New Tax Law Affects Mortgage Interest
- Bankrate: Cash-out Refinance: When is it a Good Option?
- Consumer Financial Protection Bureau: What is a Debt-to-income Ratio?
- LendingTree: Cash-Out Refinance
- The Federal Reserve Board: A Consumer's Guide to Mortgage Refinancings
With more than a decade of experience, Gregory Erich Phillips is a trusted expert on real estate and mortgage financing. As an author, Phillips is known for his writings on economics, personal finance, religion, politics and culture.