Is a Cash-Out Refinance Right for You?
August 9, 2019
In need of cash to fund home improvements or get rid of high-interest debt and have equity built up in your house? Then a cash-out refinance may be a viable option. You get the best of both worlds: access to cash at a lower cost to borrow.
Looking to fund home improvements, consolidate debt, or cover other expenditures? Then a cash-out refinance may be right for you.
With this type of mortgage loan, you get to access some of the equity you’ve built up in your home. The proceeds can be used for whatever you choose, but the two most popular reasons are debt consolidation and home improvements. A cash-out refinance is usually cheaper than using a credit card or taking out a personal loan. It can be a sound financial move if you pay down high interest rate debt or increase the value of your home with the home improvements you complete.
In the past cash-out refi loans got a bum rap. Homeowners used them as piggy banks during the housing boom of the early 2000s. When the real estate market crashed, it ushered in a period of foreclosures. These days, lending standards are much stricter, and borrowers are more prudent about accessing the equity they’ve built up in their homes. Home equity grows over time as you pay your lender each month or if the value of the property rises. Mortgage payments are typically divided into principal and interest. The principal payments go directly to the loan balance and are the main way you build equity.
Benefits of a Cash-Out Refinance
In order to take advantage of a cash-out refinance, you’ll need equity in the home. That’s the difference between the value of the property and the balance on the mortgage. Most lenders let you borrow as much as 80% of that equity, if you have excellent credit history. Let’s say you owe $200,000 on a $300,000 mortgage. Your available equity is $40,000 under the 20% rule. That is determined by taking 80% of $300,000 (or $240,000). If you borrowed $40,000, your new mortgage would amount to $240,000.
The best time to refinance your mortgage is when interest rates are lower than what you’re currently paying. With a cash-out refinance you may be able to reduce your mortgage payment and get access to some of your equity at a lower cost than other loan products. It tends to be cheaper than a home equity line of credit (HELOC) or home equity loan. Personal loans and credit cards can’t even compete.
Borrowers also get a fixed payment over the life of the loan. Making payments each month is made easier since there’s only one bill. That’s welcome news to the millions of borrowers who struggle with multiple monthly payments.
Depending on what the proceeds of the cash-out refi are being used for, it can save you money. If you pay off high-interest debt, you won’t owe thousands of dollars in interest. If the money goes for home improvements, it could raise the value of your home. Plus, you may be able to write off your mortgage interest come tax time. Talk with your tax advisor to be sure.
Given the low mortgage interest rate environment, some homeowners even use the money from a cash-out refinance to invest. There are no limitations on what your proceeds should go for, but you should make smart decisions. A cash-out refinance may not be the cheapest way to cover a short-term purchase such as a car or a risky investment. Weigh the pros and cons of using your home equity before applying for a cash-out refi.
To apply for a cash-out refinance with NewRez, click here.
Things to Consider
Even though you have an existing mortgage, you will have to go through the approval process for a cash-out refinance. You are replacing an existing mortgage with a new one. That means you’ll be put through the paces by the lender’s underwriting team. It doesn’t matter if you qualified in the past you still have to meet certain eligibility requirements to gain approval. Lenders look at your credit score, amount of equity and debt-to-income ratio. It’s the difference between your monthly debt and income expressed in a percentage. If it’s too high, you may be turned down for a refinance. If your credit score is poor and/or your DTI is above the level required, take steps to improve your financial picture before applying.
Just like with a regular mortgage, there are costs associated with a cash-out refinance. Known as closing costs, they range from 2% to 5% of the mortgage and cover a host of expenses including the origination fee, title search, and appraisal. To determine the current value of your property, the lender will order an appraisal, which is an unbiased assessment of your home. An appraiser uses recent sales data, real estate market conditions and an inspection of your property to assess its value. Typically the new mortgage is limited to 80% of the current value of the property.
A cash-out refinance also reduces the equity you have in your home and in some cases increases your mortgage payment. If interest rates have dropped since you took out your original mortgage, and you aren’t borrowing too much of your home equity, you may walk away with a mortgage payment that remains the same.
Since the cash-refi is a new mortgage, you’ll have new terms, which could lengthen the time it takes to pay it back. There are also limitations to the amount you can borrow. Keep in mind that with a cash-out refi, the loan is secured with your home.
When a Cash-Out Refinance Makes Sense
Cash-out refinance loans aren’t as popular as they were when home values were soaring earlier in the decade. For good reason. Do it for the wrong reasons and you could run into financial trouble.
But if it’s used to get rid of high-interest debt or to make home improvements that increase the property value, it can be a sound decision. You get to refinance into a lower interest rate mortgage and access some of your equity.