What Is A Cash Refinance?
A cash out refinance replaces your existing mortgage with a new home loan for more than you owe on your house. The difference goes to you in cash and you can spend it on home improvements, debt consolidation or other financial needs. This is a different process from traditional refinancing, in which you replace your existing mortgage with a new one that has the same balance.
Here’s how a cash-out refinance works:
- Cash out between 80-90% of your home’s equity
- Use the cash out loan for what you need, like a financial emergency orhome repairs
- Obtain a better interest rate or shorter loan term
For example, if your home is valued at $200,000 and your mortgage balance is $100,000, you have $100,000 of equity in your home. Let’s say you want to spend $50,000 on renovations. You can refinance your loan for $150,000, and receive $50,000 in cash at closing.
There are many pros and cons of borrowing equity from your home, and every homeowner should understand the benefits and risks of doing a cash refinance.
Lower interest rates: A mortgage refinance typically offers a lower interest rate than a home equity line of credit. A cash-out refinance might give you a lower interest rate if you originally bought your home when mortgage rates were much higher. For example, if you bought in 2000, the average mortgage rate was about 9%. Today, it’s considerably lower. But if you only want to lock in a lower interest rate on your mortgage and don’t need the cash, regular refinancing makes more sense.
Debt consolidation: Using the money from a cash-out refinance to pay off high-interest credit cards could save you thousands of dollars in interest.
Higher credit score: Paying off your credit cards in full with a cash-out refinance can improve your credit score by reducing your credit utilization ratio — the amount of available credit you’re using.
Tax deductions: Unlike credit card interest, mortgage interest payments are tax deductible. That means a cash-out refinance could reduce your taxable income and land you a bigger tax refund.
Foreclosure risk: If you can’t make the payments, you will run risk losing your home since it’s collateral for any kind of mortgage. Just make sure you have the money to make the payments.
New terms: Your new mortgage will have different terms than your original loan. Double check your interest rate and fees before you agree to the new terms.
Closing costs: You’ll pay closing costs for a cash-out refinance, as you would with any refinance. Closing costs are typically 3% to 6% of the mortgage — that’s $6,000 to $10,000 for a $200,000 loan. Make sure your potential savings are worth the cost.
PMI: If you borrow more than 80% of your home’s value, you’ll have to pay private mortgage insurance. For example, if you have a mortgage of $100,000 on a home valued at $200,000 and do a cash-out refinance for $160,000, you’ll probably have to pay PMI on the new mortgage.
Enabling bad habits: If you’re doing a cash-out refinance to pay off credit card debt, you’re freeing up your credit limit. Avoid falling back into bad habits and running up your cards again.
A cash-out refinance can be a good idea assuming you get a good interest rate, you know you can easily pay back the new loan, and you need the cash for a worthwhile cause, such as home improvements or paying down high-interest debt.
Just be careful: If you don’t pay off this loan in full and on time, you can lose your home.
Reference Credit: bankrate.com