What is Cash-Out Refinance
A cash-out refinance is a mortgage refinancing option where the new mortgage is for a larger amount than the existing loan to convert home equity into cash.
In the real estate world, refinancing is the process of replacing an existing mortgage with a new one that typically extends to the borrower more favorable terms. By refinancing, the borrower may be able to decrease their monthly mortgage payments, negotiate a lower interest rate, renegotiate the number of years – or term – of the loan, remove additional borrowers from the loan obligation, or access cash through home equity built up over time.
Rate and Term Versus Cash-Out Refinancing
The most basic option in mortgage loan refinancing is the rate and term refinance. With this option, the borrower is attempting to attain a lower interest rate and/or adjust the term of the loan. If a property was purchased years ago, the borrower might find it advantageous to refinance in order to get today’s prevailing lower interest rates. Also, variables may have changed in a borrower’s life where a 15-year mortgage may better suit their needs in comparison to their current 30-year mortgage.
A cash-out refinance allows the borrower to convert home equity into cash by creating a new mortgage for a larger amount than the original. The borrower receives the difference of the two loans in cash. This is possible because the borrower only owes the original mortgage amount to the lending institution. The additional loan amount of the cash-out refinanced mortgage is paid to the borrower in cash at the closing.
Example of a Cash-Out Refinance
Here is an illustration of a cash-out refinance. An owner has a property which has a $200,000 mortgage against it and he/she still owes $100,000 on the mortgage. The owner has built up $100,000 in home equity. So that the owner could convert a portion of that equity into cash, they could opt for a cash-out refinance. If they wanted to convert $50,000 of their equity, they could refinance taking out a new loan worth a total of $150,000. The new mortgage would consist of the $100,000 remaining balance from the original loan plus the desired $50,000 that could be taken out in cash.
Limits to Cash-Out Refinancing Options
By calculating the property’s present loan-to-value ratio (LTV), a lender can establish a maximum loan amount for a cash-out refinance. The lender looks at the current market value of the property in comparison with the outstanding balance the borrower owes on the existing loan.
If we use the above example and assume that the current market value of the property is $250,000 and that the lender has set a maximum LTV of 80%, the maximum cash-out refinance amount would be $100,000. The 80% LTV would establish that the maximum amount of the new loan would be $200,000. After the initial mortgage is paid off ($100,000), there would be $100,000 in cash available to the borrower.
Businesses usually take out loans to meet various cash flow needs of companies, for example, meeting payroll or building inventory. When a company cannot show that it can pay for a loan through its cash flows, the lender may decide to approve the loan based on the value of the entity’s assets. This form of business financing is referred to as asset-based lending.
Asset-based lending occurs when a loan is granted to a firm solely on the value of assets pledged as collateral. The terms and conditions of an asset-based loan depend on the type and value of assets offered as security to the lender. Lenders usually prefer highly liquid securities that can readily be converted to cash in situations where the borrower defaults on its payments.
In general, the more liquid the pledged asset, the higher the loan-to-value ratio. In addition, loans that are granted under asset-based financing are never the full value of the assets pledged.
For example, say a company seeks $200,000 in a loan to expand its business operations.
If the company decides to pledge its highly liquid marketable securities on its balance sheet as collateral, the lender may grant 85% of the face value of these assets.
This means that if the firm’s marketable securities are valued at $200,000, the lender will be willing to loan $170,000. If the company, however, chooses to pledge less liquid assets such as real estate, finished inventory, or equipment, it may be only to secure only, say 50% of its required financing.
Interest rates on these loans, as you can imagine, are less than interest rates on an unsecured loan or line of credit because if the borrower defaults, the lender has the ability to seize assets and sell them in an attempt to recoup its lending costs. The lender’s interest is secured by the assets of the borrower which also determines how large of a loan a company can access. The interest charged on an asset-based loan is determined by the size of the loan, and ranges from 7% to 17%, expressed as an annual percentage rate (APR).
Companies go through the route of asset-based lending for a number of reasons. The cost of issuing shares or bonds in the capital markets may be too high. A firm may also not be able to raise capital through the securities market if it needs immediate funding for a time-sensitive project such as a merger, acquisition, inventory purchase, etc. Also, if getting unsecured financing proves to be challenging, a business may opt for asset-based lending. Companies that take asset-based loans usually have cash flow problems that stem from rapid growth. Small and mid-sized companies that are stable and that have assets to be financed are common asset-based borrowers.
The assets used in asset-based lending are not normally pledged as securities for other loans. If they are pledged to another lender, the other lender must agree to subordinate its position.
What is Mergers and Acquisitions – M&A
Mergers and acquisitions (M&A) is a general term that refers to the consolidation of companies or assets. M&A can include a number of different transactions, such as mergers, acquisitions, consolidations, tender offers, purchase of assets and management acquisitions. In all cases, two companies are involved. The term M&A also refers to the department at financial institutions that deals with mergers and acquisitions.
Mergers and Acquisitions M&A
Merger: In a merger, the boards of directors for two companies approve the combination and seek shareholders’ approval. After the merger, the acquired company ceases to exist and becomes part of the acquiring company. For example, a merger deal occurred between Digital Computers and Compaq whereby Compaq absorbed Digital Computers.
Acquisition: In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or legal structure.
Consolidation: A consolidation creates a new company. Stockholders of both companies must approve the consolidation, and subsequent to the approval, they receive common equity shares in the new firm.
What is a Tax Credit?
A tax credit is an amount of money that taxpayers can subtract from taxes owed to their government. The value of a tax credit depends on the nature of the credit; certain types of tax credits are granted to individuals or businesses in specific locations, classifications or industries. Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed.
IRS PUBLICATION 514
Tax Credit’?Governments may grant a tax credit to promote a specific behavior, such as replacing older appliances with more efficient ones, or to help disadvantaged taxpayers by reducing the total cost of housing.?Tax credits are more favorable than tax deductions or exemptions because tax credits reduce tax liability dollar for dollar. While a deduction or exemption still reduces the final tax liability, they only do so within an individual’s marginal tax rate. For example, an individual in a 15% tax bracket would save $0.15 for every marginal tax dollar deducted. However, a credit would reduce the tax liability by the full $1.?Nonrefundable Tax Credits.
Non-refundable tax credits are items directly deducted from the tax liability until the tax liability equals $0. Any excess nonrefundable tax credit is not utilized (by giving the taxpayer a refund, for example), as any amount that would potentially reduce the tax liability further is not paid out. Nonrefundable tax credits negatively impact low-income taxpayers, as they are often unable to use the entire amount of the credit. Nonrefundable tax credits are valid in the year of reporting only, expire after the return is filed, and may not be carried over to future years. As of 2017, specific examples of nonrefundable tax credits include benefits for adoption, raising children, earning foreign income and paying mortgage interest.
Refundable Tax Credits
Refundable tax credits are the most beneficial credit, as they are entirely refundable. This indicates that, regardless of a taxpayer’s income or tax liability, he is entitled to the entire amount of the credit. This is true even if the refundable tax credit reduces the tax liability below $0. In that situation, the taxpayer is due a refund.
Last year was probably the most popular refundable tax credit is the Earned Income Tax Credit (EITC).
Other refundable tax credits are available for education, health care coverage and for raising children.
Partially Refundable Tax Credits.
Some tax credits are partially refundable, which can both decrease taxable income and lower tax liability. An example of a partially refundable tax credit is the American Opportunity Tax Credit, which remains in place from 2018 on under the new tax legislation. If a taxpayer reduces his tax liability to $0 before using the entire portion of the $2,500 tax deduction, the remainder may be taken as a refundable credit up to the lesser of 40% of the credit or $1,000.
A professional employer organization (PEO) is a firm that provides a service under which an employer can outsource employee management tasks, such as employee benefits, payroll and workers’ compensation, recruiting, risk/safety management, and training and development.