Cash-out refinance is common practice in real estate, however most people don’t know what it entails.
So, what is it, and how does it work?
To start, it’s important to clarify what it means to refinance a home. In a nutshell, refinancing means getting a new mortgage to replace the original one. Homeowners typically do this as a way to allow a borrower to receive a better interest term and rate. Once the first loan gets paid off, it opens the door to allow the second loan to be created.
That being said, a cash-out refinance is essentially a way to refinance your mortgage AND borrow money at the same time. A cash-out refinance replaces your current home loan with a new mortgage that’s higher than your outstanding loan balance. You’ll then withdraw the difference between the two mortgages in cash, and put the money toward other priorities or financial goals, like home renovations or consolidating high-interest debt.
What are the advantages of cash-out refinancing?
- A lower interest rate. This makes sense, as you’ll be taking on a larger loan and lowering any interest costs. If you use the cash to pay off other debts like credit cards or a home equity loan, you’ll be lowering the interest rate you pay on that debt.
- Added home improvement value. Most homeowners use the cash out refinances for home improvement projects, which can decrease the mortgage interest from taxes if these projects add substantial value to the home. Taking advantage of your home’s equity can be less expensive than other forms of financing, like a personal loan or credit cards.
- Opportunity for big life payments. Let’s say your child is going to college — using your home’s equity to make up for the shortfall can prove beneficial if the student loan rate is higher than what you’d get with a cash-out refinance. If you’re experiencing a lot of debt and seeing interest rates in the double digits, it might be worth it to punch the numbers and if you can better refinance and pay off debt this way.
What are the disadvantages of cash-out refinancing?
- It could increase the interest rate on an existing mortgage. If cash-out refinancing creates a significant spike in your rate, it probably isn’t the best move.
- It might reestablish private mortgage insurance (PMI). Some lenders allow you to withdraw up to 90% of your home’s equity. However, this means you have to pay PMI again after you’ve canceled it, which can add to overall borrowing costs.
- Repayment on existing debt might be drawn out. If you’re using a cash-out refinance to consolidate debt, make sure you’re not prolonging debt repayment.
- Risk of losing your home increases. Failing to repay the loan means you could wind up losing it to foreclosure, no matter what way you use the cash-out refinance. Make sure you don’t take out more cash than you need, and you’re using it for a purpose that improves your financial situation.
- It could develop bad spending habits. Taking advantage of your home’s equity to pay for vacations or big purchases shows that you lack discipline over your spending habits. If you’re already struggling with your spending habits, this isn’t a good option.
All in all, make sure you’re crunching the numbers carefully, so you’ll know if cash-out refinancing is the right option for you. It’s scary to put your house on the line as collateral, and you could lose it if you fail to repay the new mortgage. Visit our blog for additional resources, and contact us today if you’re looking to refinance your home.