Cash-out Refinancing Credit Traps

Once upon a time in the not too distant past, homeowners could snap their fingers and withdraw money from the unused equity in their properties via a cash-out refinance. Since the mortgage crisis, however, doing a cash-out finance has become more like a fairy tale -- both Fannie Mae and Freddie Mac have reported that the numbers for cash-out refinancings have recently hit record lows.

As home values plummeted and the job market shriveled, homeowners have been more likely eligible for foreclosure than a cash-out refinance, which requires borrowers to have reasonable home equity, abundant assets, and a steady job. If you’re one of the lucky few who is eligible, and want to take advantage of historically low interest rates, bravo. But don’t get caught in one of the following credit traps, which can derail your opportunity.

Avoid large purchases

Since June 1, 2010, Fannie Mae has been requiring banks to do a “recheck” on a potential borrower’s financial condition right before a loan can close. If there are significant changes, the bank can delay or even cancel the mortgage entirely. Therefore, it’s essential that you don’t make any large purchases, which may run up your credit card bills or deplete the assets in your bank account until after your mortgage closes. If you have a situation that requires immediate payment, like an emergency home repair, borrow money from a friend or relative instead of putting it on your credit card.

Be properly seasoned

Have you ever heard of a seasoning requirement? Most mortgage lenders have one. If you’ve tapped the equity in your home, it’s the period of time that you must wait before you can do it again. This includes a previous mortgage refinance, home equity loan, or home equity line of credit (HELOC). Each lender follows a different set of rules, but the seasoning period is generally six months to a year. If you’re lucky, you may find a lender that doesn’t have one, but in this tight mortgage market, you may need a little fairy dust to locate one.

Check your credit report

You’ve heard it before, and you’ll hear it again because it’s so important: Before applying for a cash-out refinance, contact the three leading credit agencies – Experian, Equifax, and Trans Union – and get a copy of your credit report. Review them for any incorrect information and have it corrected immediately. If you have a borderline score, a one-point difference can sometimes make a tremendous impact on the interest rate that you’ll receive, and you may even incur additional fees. You can check your credit report for free once every year from each of the three agencies by going to annualcreditreport.com. However, if you want to check your FICO score, you’ll need to pay.

If you’re lucky enough to qualify for a cash-out refinance, keep your credit clean. Then you can be assured that you won’t need the magic of a fairy godmother to make sure you’ll have a smooth closing.