Understanding how banks structure loan scenarios, can help you as the borrower better understand the interest rate that is being quoted to you by a mortgage lending bank.
The type of loan that you can apply for with a bank, can generally be put into one of three categories:
- A cash out loan
- Rate/Term
- Purchase
Now while the purchase loan transaction is pretty self-explanatory, people sometimes get mixed up over whether their loan is a cash out or rate/term transaction.
So an easy to figure out whether your loan is cash out or rate/term is by looking at the balance of your first mortgage loan.
If you are increasing the balance of your first mortgage loan then you are doing a cash out transaction.
If you are keeping the loan balance on your first mortgage the same or decreasing it, then it would be considered a cash out transaction.
So for example, if you had a loan of $450K, and you wanted to refinance it to lower your rate, but you also wanted to have access to a home equity line of credit.
Then you could put $417K on a first, (thereby putting it into the conforming loan category) and put $33K on a HELOC and this would be consider a rate and term transaction because you didn’t increase the balance on the first mortgage.
Now if you had a first mortgage of $450K and your new first mortgage loan balance was $480K, then that would be considered a cash-out transaction because the first mortgage balance increased.
Distinguishing between cash-out and rate/term loans is important because rate/term interest rate pricing is almost always better than cash-out interest rate pricing.
That’s another way of saying that if your loan is rate/term your interest rate will probably be lower than if it was classified as cash-out.
Because of this, it’s important to talk to an experienced loan officer who can help you structure your loan in a way that gives you the best possible pricing scenario.