Cash-Out Refinance 101

Are you interested in making a home upgrade or consolidating debt? A cash-out refinance may be a good option to fund your financial goals while making your equity work for you.

What is a cash-out refinance?

A cash-out refinance is a loan on a property you already own that helps you use some of the equity you’ve built up in your home when you need it most.

When you take out a mortgage on a property and begin to make payments, the amount owed on the loan goes down while your equity in the property increases. This means you own a little bit more of your home with every mortgage payment you make.

With a cash-out refinance, you replace your existing mortgage with a new one that has a higher amount owed and pocket most of the difference.

Let’s say your home is worth $240,000, and the balance remaining on your mortgage is $115,000. That means you have $125,000 of equity in your home. With a cash-out refinance, you could refinance the $115,000 balance into a new $190,000 loan and receive $75,000 minus closing costs after the transaction is complete.

A cash-out refinance may be a good option to consider when:

• Your home’s value increases significantly and interest rates are low

• You want to renovate or upgrade your property

• You’re interested in expanding your investment portfolio

• You want to consolidate debt or cover an unexpected financial burden.

Pros and cons of a cash-out

refinance

A cash-out refinance can be a great tool to help you meet your goals, but there are a few potential drawbacks to consider as well.

Pros

• Generally, you have access to a larger number of different loan programs (i.e. fixed and variable rate options) compared with other home equity loan programs
• You have just one mortgage payment to make versus two payments
• They offer stable, fixed interest rate options in addition to adjustable-rate options
• There are no limitations or restrictions on how the cash can be used after closing
• You may be eligible for possible tax deductions if the money funds significant home improvements (Consult your tax advisor to be sure.)

Cons

• They may require more documentation and take longer than getting a Home Equity Line of Credit (HELOC)
• You have to pay closing costs that eat into the equity you have available
• You may have an added cost in the form of private mortgage insurance (PMI) if your new mortgage balance is more than 80% of your home’s value

When to avoid a cash-out

refinance

While there aren’t any limitations on how you can use the money you get out of a cash-out refinance, there are situations where it may not be the most cost-effective way to meet your financial goals.

Taking out cash to purchase a vehicle, fund the trip of a lifetime, or pay for any short-term project doesn’t make sense in the long term.

For example, using a cash-out refinance to buy a new car eliminates the need for a car loan. But it stretches the money you borrowed to pay for it over the life of your new mortgage, which could be up to 30 years. So you could end up paying more in interest than you would have if you financed it and paid it off in five years with a traditional car loan.

One final word of caution about a cash-out refinance: avoid using it to enable reckless financial habits, like excessive consumer debt or risky investments. It takes years to build up equity in your home, and once the cash is gone, it’s gone.

Paying Interest & Closing Costs

Entering a cash-out refinance mortgage is similar to applying for a mortgage on a property you wish to buy. Interest rates and closing costs are part of the package, even though you receive cash once the paperwork is finalized.

Your new mortgage may have a higher interest rate than your original home loan, and you may pay more per payment each month and in mortgage interest over time. You also will have to pay closing costs to cover the loan origination and other fees associated with the transaction, which could be thousands of dollars.

Other Options to Consider

While a cash-out refinance is a relatively low-cost way to borrow money, there are other options available to take advantage of the equity in your home.

Home Equity Loans

You can take out a home equity loan, a lump sum of money you can borrow using your home as collateral independent from your existing home loan. A home equity loan allows you to borrow funds without sacrificing the progress you’ve made on your mortgage. They typically have higher interest rates, but it’s on a smaller sum of money.

And, remember, the lender can foreclose on your home if you don’t keep up with the payments.

Home Equity Line of Credit

A final option for leveraging the equity in your home is opening a home equity line of credit (HELOC). A HELOC is a revolving line of credit extended from your lender with a low-interest rate. It acts similar to a credit card in that you can borrow from it and the balance replenishes as you pay it back. Be sure to ask your lender about loan minimums and other restrictions before you apply.

Congratulations! You’ve graduated from cash-out refinance 101. Whether you’ve decided that a cash-out refinance is right for you or you want to explore more options, our mortgage loan officers are ready to help. Contact us to learn more about using your equity to fund your next big project.