Whether you are paying for college, home repair, or other big expenses, a cash-out refinance may make sense for you. Thanks to attractive interest rates, now might be the right time for you to consider a cash-out refinance. If you have a significant amount of equity in your house and would like to convert some of it to cash, a cash-out refinance is worth a look.
Let’s learn more about cash-out refinance.
What Is Cash-Out Refinance?
A cash-out refinance is a way to refinance your mortgage and borrow money at the same time. With a cash-out refinance loan, you refinance your mortgage with a larger loan that pays off your current mortgage. Cash-out refinance is a way to convert home equity into cash.
How Can a Cash-Out Refinance Help You?
You are free to use the cash from your refinance just about any way you wish. Cash-out refinance is a popular option to consolidate non-mortgage debt.
One of the most common reasons for cash-out refinance is to pay for home improvements. Cash-out refinance makes sense for home improvements because you are adding value to your home. Another popular reason for a cash-out refinance is to pay for college expenses.
You can use the money you get from a cash-out refinance in the following ways:
- Retirement funds – It pays to start thinking early about saving for retirement. If your retirement fund could use an infusion of cash, cash-out refinancing might be a great option for you.
- Debt consolidation – High-interest debt can seem like you are never going to pay it off. It might feel like you are paying a lot of money every month, but it doesn’t feel like you are making a dent in the principle. A cash-out refinance is a viable option to pay down high-interest debt. In addition to debt consolidation, you are also potentially improving your credit score.
- Buyout a co-borrower – You can use the funds from a cash-out refinance to buyout a co-borrower. If you want sole ownership in a property, you’ll need the money to make it happen.
- Home renovation – Need to remodel your kitchen, build a nursery for a baby on the way, or replace the roof? Perhaps you own an older home that needs a complete restoration. If you want to start a home renovation project, you will need an infusion of cash. A cash-out refinance allows you to use the equity in your home and increase your home’s value.
- Student loans, college expenses, and funds – You can finance your education or your children’s education with the cash you get from a refinance. Use the money to pay for tuition, college loans, or school-related expenses.
- Investing in new properties – Have you been thinking about a vacation home or an income property? The cash you receive from refinancing could help you finance a property investment. Use the money as a downpayment or to remodel the property.
How Do You Know If Cash-Out Refinance Is Right for You?
A cash-out refinance makes sense when:
- You want to consolidate non-mortgage debt.
- The cost of other financing is greater than the rate you can get on a cash-out refinancing.
- You need cash for large expenses, such as home improvements.
- You have good credit.
By considering all of the above and consulting with a lender, you can determine whether cash-out refinance is the right option for you. The key is to consider debt, interest, monthly payments, and all other expenses to make your decision.
Think about the following questions as you think about a cash-out refinance:
- How much cash do you need?
- How long do you plan on staying in your home?
- What’s the total cost of borrowing?
- How will your monthly payments be affected?
Costs of Cash-Out Refinance Mortgages
In terms of costs, a cash-out refinance works similarly to a regular refinance. There are closing costs and other expenses. These can add up to thousands. Consult with your lender to learn about all costs involved with a cash-out refinance.
For many homeowners, a cash-out refinance is an opportunity to use home equity to pay for large expenses.
Cash-Out Refinance vs. Home Equity Loan
If you want to borrow money against your home equity, you have options. One choice would be to refinance your current mortgage with a new mortgage and take some of the home equity in cash. That’s what we call cash-out refinancing. The other option would allow you to take out a home equity line of credit (HELOC).
Here are some of the key differences between the cash-out refinancing and home equity loan:
Cash-Out Refinance Loan Terms
When you choose the cash-out refinancing option, it pays off your existing home loan. When you refinance, you essentially replace your mortgage with a new one. Your new home loan might have different terms than your original mortgage. For example, you could opt for a different type of mortgage or a different interest rate, a longer or shorter time period for paying off your mortgage.
With the cash-out refinancing, there will be a new payment amortization schedule. The payment amortization schedule shows the exact monthly payments you have to make to pay off the loan principal and interest by the end of the loan term.
Home Equity Line of Credit Loan Terms
HELOC is generally taken out in addition to your existing first home loan. Essentially, HELOC is a second mortgage. It will have its own term and repayment schedule independent from your first mortgage. But, if you don’t have a mortgage on your house, some lenders might allow you to open a home equity line of credit in the first lien position. In that case, the HELOC becomes your first mortgage.
The way you receive funds would be different with a cash-out refinance and HELOC:
- With a cash-out refinance, you get a lump sum when you refinance your home loan. First, the loan proceeds are used to pay off your current mortgage, including closing costs and homeowners insurance, real estate taxes, and other prepaid items. The remaining money is yours to use as you wish.
- The HELOC option allows you to withdraw from your available line of credit. You can use the money as needed during the draw period, normally 10 years. During the draw period, you will make monthly payments that include principal and interest. After this time, the repayment period starts. Once the draw period ends, you can’t withdraw more money, and you will have to continue repayment. Generally, borrowers have 20-years to repay the HELOC.
Cash-Out Refinance Interest Rates
You can have either an adjustable-rate mortgage or a fixed interest rate mortgage through a cash-out refinance. Ask your lender about the pros and cons of your interest rate options. With the information about fixed-rate and adjustable-rate mortgage interest, you can decide which one you prefer.
Home Equity Line of Credit (HELOC) Interest Rates
The interest rate with a HELOC is variable and changes in conjunction with an index, normally the U.S. Prime Rate as published in the Wall Street Journal. Based on the same index, your interest rate may increase or decrease. Some lenders also offer fixed-rate HELOC options. A fixed-rate HELOC would allow you to convert some or all of the balance to a fixed-rate loan. Ask your lender about their fixed-rate loan conversion options.
Cash-Out Refinance and HELOC Closing Costs
If you choose the cash-out refinancing option, you can expect to pay similar to your original home loan. With the HELOC option, there is normally no closing costs.
Which is better, cash-out refinance or home equity loan (HELOC)?
Cash-out refinancing and HELOC allow borrowers to use home equity as collateral. Determining which is better for you may depend on how much equity you have in your home, creditworthiness, and current home loan.
Both loan options can help you turn home equity you have built over the years into cash you can use today. Many homeowners use these financing forms for home improvements and repairs or finance major expenses, such as college tuition or wedding costs.
Generally, home equity loans have higher interest rates than cash-out refinancing mortgages because they are second mortgages. If you fall behind on mortgage payments, the lender can only get paid after the primary mortgage holder gets money owed. Even though a HELOC has a higher interest rate, it may be offset by no (or low) closing costs.
Never assume anything about your loans. Read the fine print on your loan, as some lenders may cover closing costs but require borrowers to repay some of it if you pay off your HELOC before a certain date.
Cash-Out Refinance Pros and Cons
Pros of Cash-Out Refinance
A mortgage refinance normally offers a lower interest rate than a home equity loan, HELOC, or home equity line of credit. If you bought your home when interest rates were higher than today, a cash-out refinance might give you a lower interest rate. For instance, if you bought a home when interest rates were about six percent, you could refinance with a considerably lower interest rate. But if all you want is a lower interest rate and you don’t need cash, a regular refinancing might be a better long-term option for you.
People use cash-out refinancing as a vehicle for debt consolidation. Borrowers can use the funds from a cash-out refinance to pay off high-interest credit card debts. This strategy could save you thousands of dollars in interest. It may also help you improve your credit score due to the improved credit utilization ratio, the amount of available credit you are using.
If you use the cash to build or substantially improve your home, there might be tax deductions available for you.
Cons of Cash-Out Refinance
Your home is the collateral for your cash-out refinancing. Consequently, you risk losing your home if you default on your mortgage. If you use the money from a cash-out refinance to pay off credit card debt, you are essentially replacing unsecured debt with a secured debt. It is a real risk you should consider before going through with mortgage refinancing.
If you pay off high-interest credit card debt with the funds from a cash-out refinance, avoid running up your cards again.
Double-check the terms of your new home loan before you sign. Your new mortgage will have different terms from your original home loan. Understand the true cost of refinancing. There will be closing costs to pay, typically two to five percent of the loan amount. Calculate the costs of refinancing and only go through with it if the savings outweigh the costs.
If you borrow more than 80 percent of home equity, you will be required to pay for private mortgage insurance (PMI). The PMI number can be about one percent of the loan amount. On a $300,000 home loan, the PMI would cost $3000 per year.
Unfortunately, some people use cash from refinancing to enable bad habits. Resist the urge to run up your credit cards after you have refinanced your mortgage.
Cash-Out Refinance Example
Let’s say you took out a $300,000 mortgage to buy a property worth $400,000, and after ten years, you still owe $200,000. Assuming that the property value has not dropped below $400,000, the home equity increased to at least $200,000. If the interest rates are lower today and you want to refinance, you might get approved for cash-out refinancing.
Some people might not want to take on larger monthly payments after a cash-out refinance, but you can refinance for up to 80 percent home equity if you have enough home equity.
Cash-Out Refinance of Investment Property
People often refinance investment property to make the loan more manageable. You can also use the cash to make improvements and increase the rent on the property.
Things to Consider About Refinancing
Just like anything in life, there are pros and cons of a cash-out refinance. Do your homework, make your calculations. Think about the long-term effects of refinancing your mortgage. Don’t forget the costs involved with refinancing. Ultimately, the choice is yours. A cash-out refinance is a great option for many homeowners.