A limited cash-out refinance (LCOR) is a refinancing option that replaces your current mortgage with a new loan, often aiming to lower your interest rate, change your loan term, or switch loan types. Unlike a traditional cash-out refinance that lets you tap a significant portion of your home equity, an LCOR limits the cash you receive at closing to a small amount—usually up to 2% of the new loan amount or $2,000, whichever is less.
This type of refinance is often chosen to cover closing costs or small expenses without requiring upfront cash. The new loan balance is slightly higher than the existing mortgage to accommodate these additional costs and the limited cash payout.
For example, if you owe $250,000 on your mortgage and closing costs are $4,000, you might take out a new loan for $256,000. This pays off your old loan, covers closing fees, and provides a small cash amount up to the capped limit.
Limited cash-out refinances are treated similarly to rate-and-term refinances by government-backed lenders like Fannie Mae. They often offer better interest rates than full cash-out refinancing options. LCORs are ideal if you want to save on interest, switch from an adjustable-rate to a fixed-rate mortgage, or need a small cash amount for minor expenses.
To qualify, lenders generally require a credit score of 620 or higher, sufficient equity (typically 80%-95% loan-to-value), and an acceptable debt-to-income ratio to ensure you can afford the new payments. Keep in mind, if your loan-to-value ratio exceeds 80%, you may need to pay for private mortgage insurance (PMI).
Understanding loan terms is crucial if you’re considering refinancing. Explore our comprehensive guide on mortgage refinance to learn more about your options.
When to Choose a Limited Cash-Out Refinance
- You lack upfront cash for closing costs and want to roll those fees into your loan.
- You want to change your loan type, for example from an adjustable-rate mortgage to a fixed-rate mortgage.
- You need a small cash amount for immediate minor expenses, like emergency repairs or medical bills.
Key Differences Between Refinance Options
| Feature | Rate-and-Term Refinance | Limited Cash-Out Refinance | Cash-Out Refinance |
|---|---|---|---|
| Primary Goal | Adjust rate or term only | Adjust rate/term and cover costs with small cash | Access significant home equity for large cash funds |
| Cash Back Allowed | None or minimal | Up to 2% or $2,000 max | Large amounts, often tens of thousands |
| Loan Amount | Approximately original balance | Slightly higher than existing balance | Significantly higher than existing balance |
Common Misconceptions
- Myth: It’s the same as a cash-out refinance.
Fact: LCOR offers only a limited cash amount primarily for covering costs, whereas cash-out refinances enable larger cash withdrawals. - Myth: You can finance large purchases like cars or businesses.
Fact: The cash amount is usually too small ($2,000 max) for major purchases; it’s designed for smaller needs.
For more on important mortgage concepts like loan-to-value ratio and debt-to-income ratio, see our detailed articles on loan-to-value ratio (LTV) and debt-to-income ratio (DTI).
References
- Fannie Mae Selling Guide: Limited Cash-Out Refinance Transactions: https://selling-guide.fanniemae.com/Selling-Guide/B2-Origination-Thru-Closing/Subpart-B2-1-Loan-Purpose/Chapter-B2-1-3-Refinance-Transactions/1032996491/B2-1-3-02-Limited-Cash-Out-Refinance-Transactions.htm
- Rocket Mortgage: What Is a Limited Cash-Out Refinance? https://www.rocketmortgage.com/learn/limited-cash-out-refinance
- NerdWallet: Limited Cash-Out Refinance Explained https://www.nerdwallet.com/article/mortgages/limited-cash-out-refinance
- IRS.gov for mortgage interest deduction rules: https://www.irs.gov/taxtopics/tc505
