What Happens to a Cash-Out Refinance During Foreclosure?

A cash out refinance is subject to the same repayment requirements as any other type of loan.  During a foreclosure the impact of a cash out refinance means that if the value of the home is less than the loan amount the borrower will need to make up the difference in order to prevent the loan from defaulting.

Example of a Cash Out Refinance

A refinancing using a cash out option helps the homeowner receive the equity in the home and use the amount to pay off the existing loan.  An example of a cash out refinance occurs when a homeowner with a home worth $250,000 has an existing loan balance of $100,000 and an equity balance of $150,000.  Using a cash out refinance loan, the borrower can take out a $150,000 loan, pay off the loan balance and use the $50,000 for other purposes.

Cash Out Refinance Benefits

The benefits of a cash-out refinance is that it allows the borrower to take advantage of the increase in equity above the loan amount and allows the borrower to pay off the loan.  This also results in a new loan balance for the borrower that has to be paid off and if the home, which in many cases is used as collateral for the refinance, goes into foreclosure, it will result in loss of the home and its equity to the lender.

Potential Capital Gains Liability

Additionally, if the lender sells the refinanced home and receives an amount that is higher than the amount needed for the loan, the resulting capital gain will be credited to the borrower.  Even though the borrower does not receive the sale proceeds, the amount of capital gains that exceeds a predetermined amount will be subject to income tax reporting.

Reason for Cash Out Loans

Refinancing is a recommended process for individuals facing foreclosure or potential foreclosure.  A refinancing can help a home owner or borrower take advantage of lower interest rates or reset the terms of the loan in order to make repayment easier.  With a cash out refinance the borrower benefits from the difference between the home’s loan value and the equity available for loan, where the equity is higher than the remaining loan balance.  

As long as the home is not in foreclosure, the cash out refinance will provide additional benefits for the homeowner in retiring the outstanding loan debt and paying off any other liabilities.  When a home goes into foreclosure, the borrower may be subject to losing the home as well as any advantages tied to the refinance.  This can place an additional burden on the homeowner since they will still be responsible for the new outstanding loan obligation.