A foreclosure bailout is a rare loan and a type of refinance mortgage that helps people who have gotten behind mortgage to refinance out of the old mortgage that is in the process of foreclosing on them, due to missed payments.

When someone applies for a foreclosure bailout, the new loan amount has to cover the old mortgage balance, back interest and penalties, closing costs, and attorney fees. While a foreclosure bailout is a messy proposition, it can be used when someone does not want to lose his home and has recovered his ability to repay a mortgage. Foreclosure bailouts require much higher rates, usually 56 percent above market, low debt-to-income ratios, and a 35-40 percent equity position.

Comparing Cash-Out and Rate-and-Term Refinances

Cash-out refinances can carry slightly higher fees, and loan amounts are limited to lower loan-to-values (LTVs) than a rate-and-term refinance. Often, this additional fee is ¼ point in additional charges, meaning that on a $400,000 loan, a cash-out fee might be $1,000. Other states with more stringent cash-out requirements, such as Texas, might add even more to the charges.

There are more restrictive LTV requirements. Whereas cash-out LTVs are limited to 90 percent of the value of the property (80 percent in Texas), rate-and-term refinances can go higher than that. A rate-and-term refinance will only include the current loan balance plus any accrued interest, closing costs incurred in the refinance, and any escrow or impound account. Again, except for Texas, one can typically receive less than 1 percent of the loan amounts as cash back at closing and still call it a rate-and-term refinance without the additional restrictions that cash-out loans have.

Rescission Period

One feature a refinance has that no other loan has is a rescission period – a three-day time frame after closing papers have been signed and before the loan can officially fund. It’s nothing more than a “cooling off” period to allow you to re-think your refinance loan and make sure you really, really want to do it.

Let’s say you got a cash-out loan and you lowered your monthly payment just a little, but you also got enough money to pay off a couple of automobile loans and all of your credit balances. You thought about it and thought about it, and finally the loan officer talked you into taking the cash-out loan, and not just a simple rate-and-term refinance. You had wondered throughout the approval process if the loan officer was really acting in your best interest or was simply trying to increase the loan amount so she could get a bigger commission check. Nevertheless, you decided to go ahead and close. At the closing table, you sign a piece of paper called a rescission notice, which explains the rescission process. You have three business days – including Saturday – before this loan will officially close. If you change your mind during that time, you simply have to fax or email the lender of your desire to cancel the loan.

Even while you were at the closing table, you were still wondering if this was a smart thing to do, but then realized you had three days to think it over before everything became official. So you signed your papers, took your copies home, and reviewed them over the weekend.

After a couple of days of contemplation, you made up your mind: if you were refinancing to pay off some cars and credit balances, it was wiser to go ahead and pay off the cars early and the credit cards off completely, without adding more debt to your mortgage. The monthly savings on your new mortgage will help pay off those cars and credit cards quicker, and you won’t be financing them over the next 30 years with your new 30-year mortgage.

On Monday, you sign your rescission papers and fax them back to the settlement agent, who will then cancel the loan for you. You don’t even need to have a reason. You can say you’re canceling because your baseball team lost last night. It doesn’t matter. Or you can have a darned good reason for rescinding: your interest rate wasn’t what was quoted to you by your loan officer, or the closing costs are sky-high. You name it, you can use it.

A common question comes up when people do rescind: “Do I owe everybody money if I cancel my loan?” No. Lenders might charge a loan-processing fee or an underwriting fee, but if the loan doesn’t close, you don’t have to pay for it. The same thing goes for attorney or settlement fees – if the loan rescinds, you walk away without being responsible for all those charges.