Freddie Mac Guidelines: Special Purpose Cash-Out Refinance

What Is a Special Purpose Cash-Out Refinance

A special purpose cash-out refinance lets you buy out a co-owner's equity in a property you jointly own. This typically happens during divorces, breakups, or when business partners want to separate their real estate holdings.

Say you and your ex-spouse own a home worth $400,000 with a $200,000 mortgage balance. Your ex wants their $100,000 share of the equity. Instead of selling the house, you can do a special purpose cash-out refinance for $300,000. This pays off the existing $200,000 mortgage and gives your ex-spouse $100,000 for their share.

The key difference from a regular cash-out refinance is restriction. You cannot pocket any of the proceeds yourself. Every dollar of cash-out must go to the co-owner you are buying out.

Ownership and Occupancy Requirements

Fannie Mae requires that you and the co-owner have jointly owned the property for at least 12 months before you apply for the loan. This prevents people from quickly adding someone to the deed just to access this loan type.

Both you and the co-owner must have used the property as your primary residence. The lender needs documentation proving you both actually lived there, not just owned it on paper.

There is one major exception to these rules. If either party inherited their ownership interest in the property, they do not need to meet the 12-month ownership requirement or the occupancy requirement. This makes sense — you cannot control when someone dies and leaves you property.

What You Can Use the Money For

The loan proceeds can only cover specific costs related to the buyout. You can pay off the existing first mortgage, regardless of how old it is. You can also pay off any junior liens like second mortgages or home equity lines of credit.

You are not required to pay off junior liens if they meet Fannie Mae's requirements for secondary financing [[4204.1]] or Affordable Seconds [[4204.2]]. This gives you some flexibility in structuring the transaction.

The loan can also cover normal closing costs associated with the refinance. This includes appraisal fees, title insurance, attorney fees, and lender charges.

Required Documentation and Agreements

You must provide a written agreement signed by all parties that spells out the property transfer terms and how the refinance proceeds will be distributed. This document protects everyone involved and gives the lender clear evidence of the transaction's purpose.

The lender needs proof that both you and the co-owner lived in the property as your primary residence. This might include utility bills, voter registration records, driver's license addresses, or tax returns showing the property address.

Your lender will keep copies of the occupancy documentation and the written buyout agreement in your loan file. These documents are crucial for Fannie Mae compliance.

LTV Limits and Standard Cash-Out Rules

Special purpose cash-out refinances must meet the same loan-to-value ratio limits as regular cash-out refinances. For most properties, this means a maximum 80% LTV ratio, though some loan programs allow higher ratios.

If you are refinancing a manufactured home, different LTV requirements apply under section 5703.8(a). For all other property types, the standard cash-out LTV limits in section 4203.1(b) govern your transaction.

The loan must meet all other Fannie Mae requirements for cash-out refinances. This includes debt-to-income ratio limits, credit score requirements, asset verification, and income documentation standards.

Why These Rules Exist

Fannie Mae created these restrictions to prevent abuse of the cash-out refinance program. Without the ownership and occupancy requirements, people could add friends or family members to their deed temporarily just to access cash through a buyout scenario.

The 12-month ownership requirement ensures the co-ownership arrangement was legitimate and established. The occupancy requirement confirms both parties had a real stake in the property as their home.

The prohibition on the remaining borrower receiving proceeds prevents this from becoming a way to circumvent normal cash-out limits. If you could receive money yourself, this would just be a regular cash-out refinance disguised as something else.

Common Complications and Gotchas

Timing can create problems with these loans. If you are going through a divorce, you need to coordinate the loan application with your legal proceedings. Some divorce decrees require the property to be sold rather than bought out, which could conflict with your refinance plans.

The written agreement requirement trips up many borrowers. This document needs to be detailed and signed before you apply for the loan. A simple handshake deal or verbal agreement will not satisfy Fannie Mae requirements.

Property valuation can also cause issues. If the appraisal comes in lower than expected, you might not be able to borrow enough to complete the buyout. This is especially problematic in declining markets or with unique properties that are hard to value.

Credit fees apply to these transactions, and they can be substantial depending on your loan amount and risk factors. Review Exhibit 19 in the Fannie Mae guide to understand what additional costs you might face.

References

For the official guidelines, see 4301.6: Special purpose cash-out refinance Mortgages in the Fannie Mae Selling Guide.