The Veridian Blog

Imagine you are happily set to fund and close escrow on a low-interest, no-cost refinance in a few days.  You've just received your quarterly bonus and didn't want to invest it in the troubling stock market so you've decided to make an extra principal payment on your current loan.  Unfortunately, bad news awaits you around the corner - do you know what?

We advise all clients to refrain from paying down their loan balance during the refinance process because it almost always triggers a cash-out (usually defined as the greater of 2% or $2000 cash back) characterization, and hence, greater closing costs or a higher interest rate.  Even though you just put in your own money, as soon as the lender finds out from the payoff demand that you will be getting more money back because there's suddenly less to pay off, it will be characterized as a cash-out loan.  Not only might it delay closing because the file may have to be underwritten again, but it may also trigger an "add-on" in points/fees or rate for the cash-out program.  As you may imagine, all this may unbelievably stem from a silly mistake that could have been easily prevented.

If there was enough time, then you could simply lower the loan amount so you wouldn't receive any or little cash back, however, because the transaction is very close to the end and you've probably already signed, it is too late to change the loan amount unless we are able to extend the rate lock expiration (which would likely trigger additional fees also).  In the good 'ol days, lenders sometimes allowed escrow to simply hold a certain amount on the borrowers behalf to immediately pay down the loan after close of escrow so that they don't receive any cash back at all.  But in these times, it would be rare to impossible to see that happen again.

In this scenario, your only other hope would be if your loan amount is a traditional conforming amount of $417,000 or less, then the cash-out penalty is zero, as long as Fannie/Freddie loan-to-value guidelines are met.  In that case, the lender may require a short revision form or letter of explanation, but the potential problem is far less than that with a larger loan amount.