August 30th, 2019 11:45 AM by Jackie A. Graves
refinance replaces your current home loan with a new mortgage for more than
your outstanding loan balance. You withdraw the difference between the two
mortgages in cash and put the money toward home remodeling, consolidating
high-interest debt or other financial goals.
a cash-out refinance works
When you refinance a mortgage, you simply replace the
existing loan with a new one for the same amount, usually at a lower interest
rate or for a shorter loan term.
refinancing, however, is different because you’re withdrawing a portion of your
home equity in a lump sum. You’ll pay slightly higher interest rates for a cash-out
refinance because you’re increasing the loan amount. Lenders limit the amount
you can withdraw to no more than 80 percent of your home’s value to ensure you
maintain an equity cushion.
Let’s look at
an example of how cash-out refinancing works.
Say you still
owe $100,000 on your home and it’s now worth $300,000. Let’s assume that
refinancing your current mortgage means you can get a lower interest rate and
you’ll use the cash to renovate your kitchen and bathrooms. Lenders generally
require you to maintain at least 20 percent equity in your home after a
cash-out refinance, so you’d be able to withdraw up to $140,000 in cash.
As of June
2019, 8.2 million homeowners could benefit from refinancing their current
mortgage — 66 percent more than in May, according to the latest prepayment activity report from
to use a cash-out refinance
many advantages to using a cash-out refinance over other types of loan products
if you need a large sum of money. Here are some common reasons to use a
Get a lower interest rate on their
mortgage. This is the most common reason why most people do a traditional
refinance, and it makes sense for cash-out refinancing, too, because
you’ll be taking on a larger loan and lowering your interest costs.
Make value-added home improvements or
repairs to your home. Homeowners who use cash-out refis for these type of
projects can deduct the mortgage interest from their taxes. Also, tapping
your home’s equity could be less expensive than other forms of financing,
such as a home equity loan, personal loan or credit cards.
Consolidate and pay off high-interest
debt. This move might make financial sense, but make sure the math checks
out, says Greg McBride, CFA, Bankrate chief financial analyst. “Cash-out
refinancing is beneficial if you can reduce the interest rate on your
primary mortgage and make good use of the funds you take out,” he says.
Help pay a child’s college tuition. If
your adult child needs help paying for college, using your home’s equity
to make up the shortfall can be a prudent move if student loan rates are
much higher than what you can get with a cash-out refinance. If you have
significant debt with double-digit interest rates, then it’s worth it to
crunch the numbers to see if you come out better refinancing your house
and paying off the debt that way.
of using a cash-out refinance
refinancing isn’t always the best move for every situation. Here are some
reasons to avoid a cash-out refinance:
mortgage insurance, or PMI. Some lenders let you withdraw up to
90 percent of your home’s equity, but doing so might mean you must pay PMI
again after you’ve canceled it. That can add to your overall borrowing
costs in the long run over other types of financing.
Drags out the repayment of an existing
debt for decades. If you’re using a cash-out refinance to consolidate
debt, make sure you’re not prolonging debt repayment over decades when you
could have paid it off much sooner and at a lower total cost otherwise.
“Keep in mind that the repayment on whatever cash you take out is being
spread over 30 years, so paying off higher-cost credit card debt with a
cash-out refinance may not yield the savings you’re thinking,” McBride
says. “Using the cash out for home improvements is a more prudent use.”
Heightens risk of losing your home. No
matter how use you use a cash-out refinance, failing to repay the loan means
you could wind up losing it to foreclosure. So don’t take out more cash
than you absolutely need and ensure you’re using it for a purpose that
will improve your finances instead of worsening your situation.
Tempts you to use your home as a piggy
bank. Tapping your home’s equity to pay for lavish vacations or purchases
indicates a lack of discipline over your spending habits. It’s a place to
live and not your personal ATM. If you’re struggling with getting your
debt or spending habits under control, consider seeking help through a
nonprofit credit counseling agency.
much money can I get from a refinance with cash-out?
typically allow homeowners to borrow up to 80 percent of the home’s value, the
threshold can vary, depending on your credit score and type of mortgage.
offer loans insured by the Federal Housing Administration, or FHA, sometimes
offer a cash-out refi option for FHA loans that
allow you to borrow as much as 85 percent of the value of the home. In
addition, cash-out refi loans guaranteed by the U.S. Department
of Veterans Affairs are available for up to 100 percent of the
are the fees for cash-out refinancing?
Expect to pay
about 3 percent to 6 percent of the new loan amount for closing costs to do a
cash-out refinance. Your closing costs will include lender origination fees and
an appraisal fee to assess the home’s current value. Shop around with multiple
lenders to ensure you’re getting the most competitive rates and terms.
You might be
able to roll the loan costs into your new mortgage to avoid up-front closing costs, but you’ll
likely pay a higher interest rate. Plus, taking out another 30-year loan or
refinancing at a higher interest rate might mean you pay more in total
interest. Crunch the numbers to make sure the math
works in your favor.
to a cash-out refi
other options you should consider before you start comparing rates on a
cash-out refi, including:
A home equity line of credit or HELOC allows
you to borrow money when you need to with a revolving line of credit, similar
to a credit card. This can be useful if you need the money over a few years for
a renovation project spread out over time. A HELOC interest rate is variable
and changes with the prime rate.
A home equity loan is a second mortgage
that gives you a lump sum amount and the interest rate is fixed, which helps
homeowners budget for another monthly payment.
A reverse mortgage allows homeowners age 62
and up to withdraw cash from their homes and the balance does not have to be
repaid as long as the borrower lives in the home and pays their property taxes
and homeowners insurance.
numbers carefully to ensure that a cash-out refinance is the right avenue for
your financial needs. Remember that you’re putting your house on the line as
collateral, which means you could lose it if you fail to repay the new
mortgage. Tapping your home equity isn’t a decision to make lightly, but doing
so can offer you a strategic way to improve your overall financial picture if
done with care.
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