One of the best ways to get some quick cash is to use a cash-out refinance to tap your home’s equity. This allows you to use that cash on something like remodeling, high-interest debt consolidation, and home improvements as well as any other financial goals you might have set for yourself.
The way that traditional refinance works is that it replaces your existing mortgage with a new one at the same balance. A cash-out refinance differs in a few key areas:
- It pays the difference of your home’s value and your mortgage balance.
- It has a slightly higher interest rate to account for the higher loan amount.
- It limits cash-out amounts to 80 to 90 percent of your home’s actual equity.
In other words, you simply can’t pull out 100 percent of the equity on your home. For instance, if you have a home that’s valued at $400,000 and you have a mortgage balance of $200,000, then you have a home equity of $200,000.
The pros of a cash-out refinance.
First of all, if you have a cash-out refinance, you’ll be looking at lower interest rates. In fact, a cash-out refinance might end up giving you a lower interest rate if you first bought your home when mortgage rates were higher. However, if you only want to lock in that lower interest rate but don’t need the cash, then regular refinancing will suit you just fine.
Secondly, you have debt consolidation. By using the money you get from a cash-out refinance to pay off high-interest credit cards could end up saving you literally thousands of dollars in interest.
It will also give you a higher credit score. Paying off your credit cards to the full amount can give you a higher credit score when the amount of available credit that you’re using is taken into account.
There are also tax deductions that you can take advantage of. While credit card interest is not tax deductible, mortgage interest payments are. This means that a cash-out refinance can reduce your amount of taxable income and can also ensure that you get a higher refund on your taxes.
The cons of a cash-out refinance.
The second thing to consider is that you’ll be looking at new terms for this new mortgage. Be sure to double check the interest rate to see that it hasn’t been increased without you knowing.
You’ll also have closing costs the same as you would for any type of refinance. Make sure that your savings will be worth the cost of closing.
If you borrow more than 80 percent of your home’s value, you’ll then have to pay for private mortgage insurance. This can really add up and make a cash-out refinance cost prohibitive if you aren’t careful in checking the terms of your private mortgage insurance.
Lastly, if you’re doing a cash-out refinance to pay off old credit card debt, be sure to correct your habits so that you don’t have to end up repeating this process all over again. It’s really all about freeing yourself up to make more responsible financial decisions in the future.
The Bottom Line
The bottom line on a cash-out refinance is that it can make plenty of sense if you can end up getting a good interest rate on this new loan and if you have a smart and sensible reason for the loan. However, seeking out this loan for the purposes of getting a new car or funding a vacation is a really bad idea. This is because there’s little to no return on that money that you’ve just received.
Instead, if you use this money to get renovations on your home done or to consolidate debt, then you’ll be either rebuilding the equity that you lost or help you get more secure from a financial perspective.
While this list isn’t exhaustive, it should give you an idea as to what the pros and cons of a cash-out refinance really are in the long run.