If you have considerable equity in your home and need extra cash for major expenses, such as home improvements, starting a business, college tuition, or consolidating credit card debt, a cash-out refinance of your home could be an option.
Many homeowners refinance their home loans to get a lower interest rate and better payment terms. A cash-out refinance happens when the homeowner gets a new loan for more than is currently owed on the property.
For example, you need $50,000 to start a new business. You still owe $200,000 on your home valued at $400,000. If you take out a cash-out refinance loan of $250,000, pay off your existing loan, then you can use the remaining $50,000 equity cash for your business.
However, there are a number of things to consider – both good and not so good – before you take that step.
- A means of meeting big expenses while reducing interest payments. The equity you have in your home is an asset – it may be substantial but you can’t just write a check to access it. A cash-out refinance allows you to tap into those accumulated funds for major expenses and is usually much less expensive than unsecured personal loans or charges to your credit card(s). With lower mortgage interest rates, you may pay less interest and possibly your monthly payments may be lower when compared to other options.
- More stable option than home equity line of credit. For major home renovations or upgrades, some homeowners consider a home equity loan (second mortgage) or a home equity line of credit instead of a cash-out refinance. With a second mortgage, you get the borrowed funds as a lump sum. With a line of credit, a maximum amount is approved and you can make periodic withdrawals from the loan until you reach the maximum. Both types put an additional lien on the home. Lines of credit often have adjustable interest rates that make repayments somewhat unpredictable. In contrast, with a cash-out refinance, your interest rate remains steady for the loan term.
- Refinance requirements similar to original home mortgage. The property will need a current appraisal, and your credit score will be reviewed. You will also need to provide income tax returns and W2s for several years as well as recent bank statements. Other documentation may be required, depending on your individual circumstance. There will be closing costs and fees (points). Be sure that you have, and understand, all costs involved before proceeding with a refinancing arrangement.
- Cash-out refinance benefits. Pulling out equity in your home often allows you to receive more money than you can get from a personal loan or from a credit card. The interest you pay on a refinance is in mortgage-rate ranges. If you use a credit card, annual interest rates could be 10-20% higher. Mortgage interest may be tax-deductible; credit card interest is not.
- Cash-out refinance cautions. Using the cash equity in your home for short-term needs such as paying off credit card debt can be risky, especially if you haven’t changed your credit card spending habits. You are increasing the loan amount when taking out a new mortgage, typically for 15-30 years, which means it will take longer to pay it off. If housing prices go down, you could end up “underwater” (owe more than your home is worth).
Bottom line: a cash-out refinance can be a valuable financial tool to meet sudden emergency needs or to pay for a renovation that will improve your home’s value. Like any other major financial commitment, it is one you and your family should consider carefully before you take money out of your home equity “piggy bank.”
If you're ready to buy or refinance a home please contact us find the best option for you.