A cash-out refinance means using your home’s equity to replace your current mortgage with a bigger one, with some of the difference being given to you as cash that you can use at your discretion for home improvements, debt consolidation, or other purposes. Cash-out refinancing can be a useful option if you have accumulated enough equity in your home and want to take advantage of today’s low interest rates to get a better rate on your mortgage.
How does a cash-out refinance work and how is it different than a traditional refinance?
When refinancing a mortgage, essentially you have two choices. You can refinance your current mortgage with a new loan to lower the interest rate and/or term of the loan, which would be a rate & term refinance. The other option is a cash-out refinance, where you would replace your current mortgage with a new loan in an amount larger than what you owe on the property, with the difference given to you in cash. It’s important to note that there are limitations on how much cash is available to you, depending on the current value of your home, your credit score, the loan-to-value ratio and other factors.
When should you use it?
- If you want to make home improvements, a cash-out refinance may be a good idea because you can often take advantage of a lower interest rate than other loan products.
- If you have debt that you want to consolidate, you may be able to pay off higher interest loans such as credit cards or even consolidate a home equity line of credit (HELOC) with a cash-out refinance.
- If you have other large expenses, a cash-out refinance may be a cost-effective way to get the cash you need.
What to be aware of:
- Closing costs/fees: any type of home refinance comes with closing costs and other fees, so it is important to take these into financial consideration before you begin. There are options to lower your costs by paying a slightly higher interest rate, which is known as a ‘lender credit’. When you receive lender credit, you pay less upfront, but you pay more over time with a higher interest rate. Ask a mortgage loan officer which would be best for your needs.
- New loan terms: your new loan will have new terms and a new rate. The loan will include the remaining balance on your property plus the additional cash you took out. Make sure your new monthly mortgage payment amount will fit your budget.
- Using for luxury expenses: you’re free to use the cash however you want, but be wary of using it for short-term purchases that won’t gain you a return, such as a vacation or car purchase. Instead, consider using it toward paying down higher interest debt or improving your home.
The Takeaway:
A cash-out refi can be a cost-effective option for borrowers who have equity in their home and need cash to complete home projects or consolidate bills. Today’s low interest rates mean that you could save money on your loan term as well as get needed funds right now, but be sure you have a good understanding of your financial picture, the cost of refinancing and the purpose for the additional money before you start.
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