A cash out refinancing of your home to pay off credit card bills or other high interest debt or to purchase desired toys or vacations was very common until the housing bubble burst in 2007. Since that time most homeowners were unable to do a cash out refinance do to stricter lending requirements and falling home values. However, with recent home price appreciation, cash out refinance programs and opportunities are back. If you are a homeowner with equity in your home or condo, a cash-out refinance may be a decent option to pay for home improvements or maybe pay off some high interest debt like credit cards or personal loans.
What is a cash out refinance?
A cash out refinance is where the borrower gets a new mortgage with a larger principal than the first or older mortgage and gets cash back. So for example, if your mortgage is $100,000 and you home is worth $200,000, you could get $50,000 in cash but your new mortgage would be $150,000. This type of refinance should be for the financially responsible. It works well when home loan rates are relatively low as it is one of the more attractive ways to borrow some money. With cash out refinancing, you refinance your mortgage for more than you currently owe, then pocket the difference.
Benefits of a cash out refinance
- A cash out refinance can lower borrowing costs.
- A cash out refinance can improve your cash flow and reserves.
- Using a cash out refinance to pay off high interest debt, can put you or your family in a different and arguably, better cash flow position. Although you are borrowing debt, you’re borrowing at a cheaper rate. And you’re only making one payment each month whereas you could be paying 3-6 different lenders. So, it can also be viewed as a convenience factor.
- Using a cash out refi to save emergency funds is also becoming a popular option in case people lose their jobs, for example.
- A cash out refinance offers better interest rates, and lower interest rates than on a home equity loan and other loans such as a home equity line or a personal/business loan.
- One of the major benefits of a cash out refinance is the tax issue. You can write off mortgage interest. If you have credit card debt, you can’t write off that interest each month.
Drawbacks of a cash out refinance
Cash out refinances typically have fees and various risks among the drawbacks. Some fees include closing costs. This is a refinance and refinancing has closing costs fees. However, these costs may be somewhat insignificant if you have a good credit score and enough equity in your home.
On the other hand, if your credit score isn’t ideal and your equity in your home is minimal, you may want to re-think an cash out refinance as lenders will most likely charge you more in closing costs. And, if you borrow more than 80% after the cash out refinance, you may be required, through your lender, to get mortgage insurance which could add even more to your bottom line.
Refinancing your home means you will have a longer time to pay off a mortgage. You may think twice about taking cash out if you’re close to the end of your mortgage payments as refinancing may set your re-payment structure to anywhere from 15-30 years. It depends on your terms. If you need to borrow money, maybe a home equity line of credit is more up your alley. You also need to consider if your home has the chance of being worth less than your debt – ie, becoming underwater on your loan.
Also, if your home price declines you have the risk of going underwater.
How does a cash out refinance differ from a home equity loan?
- A home equity loan is a separate loan on top of your first home loan/mortgage.
- A cash-out refinance is a replacement of your first mortgage.
- The interest rates on a cash-out refinancing are usually, but not always, lower than the interest rate on a home equity loan.
- You pay closing costs when you refinance your mortgage.
- Generally, you don’t pay closing costs for a home equity loan.
- Closing costs can rack up to hundreds or thousands of dollars.
- A cash out refinance would not make sense when the rates are higher than your first mortgage. If your current mortgage is at a lower interest rate than you could get now by refinancing, it probably makes a little more sense to get a home equity line of credit or loan. Or, if you’re 20 years into a 30 year mortgage, you are paying more principal than interest with each mortgage payment and may not want to restart another 30 year mortgage.
Is cash out refinancing right for me?
It depends on a few things. Are you looking to buy something special? Are you looking to have a little extra money in the bank? Want to go on a special vacation? When you decide whether a cash out refi is the best option for you, you should keep in mind that you’ll have to pay PMI or private mortgage insurance if you end up borrowing more than 80 percent of your home’s value. If paying PMI makes the deal unattractive, you may want to opt for a home equity loan.
Is the cash for a short-term purpose or a long-term purpose? If you are going to make payments for 15 or 30 years, it makes sense to spend the money on something enduring like an addition to the house that will increase its value. If you are going to use the extra cash to
reduce high interest credit card debt you will be paying a lower interest rate and you can take a tax deduction, but you are probably lengthening the time it would take to pay off the credit card debt. In other words, you are taking 30 years to pay off credit card debt that you might have been able to tackle in five or 10 years by cutting other expenses or taking out a shorter term home equity loan.
As always, shop and compare, service, costs and your comfort level with the lender you choose to do your cash out refinance with are all very important and should be considered.
Other Refinance Programs: