Definition of Purchase Money, Cash Out, and Rate /Term Mortgages

Purchase Money: This is a loan that enables you, in combination with your down payment, to actually purchase the property. If you spend cash to buy the property and get a loan the next day, that is not a purchase money loan. Whether it is or is not a purchase money loan has significant tax consequences everywhere, and significant legal consequences almost everywhere.

Rate/Term Refinance: This is a refinance that does not put money in your pocket for other purposes. As it is more usually defined, this is a refinance that does not put significant numbers of dollars in your pocket. These loans typically have the best rates of the three purposes. For A paper rate/term, you are allowed to pay off an existing first mortgage against the same property, you are allowed to borrow enough money to "seed" a new impound account, you are allowed enough money to pay up to one month of prepaid interest, and you are allowed up to 1% of the new loan amount, or $2000, whichever is less, to be put into your pocket for other purposes. In order to qualify as rate/term, A paper cannot do anything with an existing second (or third) mortgage, unless every last cent of that second (or third) mortgage was spent in acquiring the property, a fact which can force you to either do a cash out refinance or to subordinate your existing second mortgage to a new first trust deed. Sub-prime may have more forgiving definitions regarding other debts, but choosing a sub-prime loan because it allows your new loan to be defined as a rate/term refinance is like voting Cthulhu for President because you're tired of voting for the lesser of two evils. Sub-prime loans have pre-payment penalties by default, and generally carry higher rates.

The difference in tradeoffs between rate and cost can be small to non-existent between rate/term and cash out refinances, particularly at lower loan to value ratios. The difference also varies depending upon credit score, size of loan, and individual lender policy, but it can be quite steep. The point is to get an honest discussion of your options beforehand, not simply to sign up with some lender who pretends that the difference doesn't exist.

Cash Out Refinance is any refinance that does not meet the definition of rate/term. It puts cash in your pocket, it pays off other debts, it includes or combines or refinances a home equity loan or home equity line of credit that you took out for improvements or to pay other debts. Violating any of the requirements to be considered rate/term means that the loan becomes a "cash out" loan. Cash out refinances will usually have the least favorable set of rate and cost trade offs, what the uneducated think of as "highest rates" of these three purposes, at least at higher loan to value ratios. Depending upon the lender, cash out loans with loan to value ratios under seventy to sixty percent may have the same rate structure as rate term refinances. Cash out refinances also usually have slightly tougher underwriting guidelines than either of the other two categories. One specific example that trips a significant number of people is that there cannot have been anyone added to title in the last six months.

Caveat Emptor

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