Cash-Out Refinance: What Is It?
In simple terms, when it comes to home mortgage refinance, you’re basically replacing the total current mortgage on your property with a brand new one and preferably one with lower interest.
For instance, if you have a current balance mortgage of $200,000 on your property, a refinance will replace it with a new mortgage of $200,000.
However, in the case of cash-out refinance, the balance of the new mortgage is not just increased, but you can also take the excess money in cash. For example, if your current mortgage has $100,000 left on it and you receive a new mortgage of $150,000, you can keep that extra $50,000 (excluding closing costs and other charges related to the refinancing).
What Can The Cash Be Used For?
In short, you can use it any way you want. A popular option is to pay off your high-interest credit card debt. In the end, you’ll still have to pay the same amount of money, but you’ll be able to save a generous amount in monthly interest payments. At the time of closing, your lender will directly pay off your previous lender.
If you’re going to refinance & Cash out for your short-term expenses, you must be very cautious. For instance, if you’re going to access a cash-out refinance to purchase a car that you’ll not be using for more than five years and not paying off within that timeframe, you could end up paying 25 years of interest.
What Are The Benefits Of A Cash-Out Refinance?
In certain circumstances, a cash-out refinance can prove to be very helpful. Here are some of its advantages:
- If you roll other debts into your mortgage, the interest paid on it can be deductible keeping in mind that you must itemize deductible loan eg, any items purchased for your investment property.
- Cash-out refinances can be very advantageous if the market rate has fallen since you took out your mortgage. In such a case, you can not only borrow money but decrease your mortgage rate as well.
- If you have a huge debt that must be repaid within 5-10 years, a mortgage loan can be helpful as they can be paid over a significantly longer period of time in comparison to other forms of debt. In such a case, your payments will be easier to manage.
- The interest rate on a cash-out refinance is generally lower in comparison to other forms of debt eg, car loan, credit card debts and personal loans. You can use the cash to repay those debts at a lower rate and same terms or even shorter term.
What Are The Drawbacks Of A Cash-Out Refinance?
As with any other form of mortgage, there are certain risks associated with a cash-out refinance. The disadvantages can be elaborated as under:
- If you’re unable to repay your cash-out refinance loan, you’ll end up losing it to foreclosure. Never take out more cash than you need and ensure that the loan will improve your financial condition and not worsen it.
- If you’re going to cash-out refinance to consolidate your current debt, ensure that you’re not prolonging the repayment period if you’re able to repay it much sooner.
- Some lenders may even allow you to withdraw 90% of your home equity, but you must be careful as in such a scenario as you’ll have to pay Lenders Mortgage Insurance. In the long run, this will add up to your total borrowing costs.
- Generally, you must use a cash-out refinance to improve your current financial situation and get a lower rate. If opting for a cash-out refinance significantly increases your rate, it might not be a good decision.
How Much Money Can I Receive Through Cash-Out Refinancing?
How much you can take out depends on a few factors:
- Borrowing equity
- Mortgage balance
- Home value
- Borrowing Capacity
To understand how much your property is worth, your lender will use either an automated valuation model or a physical appraisal. Generally, you can borrow anywhere from 80-90%. The remaining 10-20 % is your retained equity. Subtract the existing debt of your current mortgage, and the remaining amount is the cash you’ll get.