Cash-out refinances have been in the news lately, and you may be wondering what they are and if one would be appropriate for you. Simply put, a cash-out refinance allows you to refinance your current mortgage and borrow more money. The money from a cash-out refinance can be used in any way, though some may carry more risks than others. Let’s take a look at the advantages and disadvantages of a cash-out refinance.
What is a cash-out refinance?
When you get a cash-out refinance, you get a new loan on your home that is for more than what you currently owe on the house. That extra money is given to you as cash, and you can do whatever you like with that money. This includes making improvements to your home, consolidating debt, paying medical bills, financing an education, or even starting a new business. In order to qualify for a cash-out refinance, you must have equity in your home. Ideally, after you refinance you would still have at least 20 percent equity remaining.
Pros of a cash-out refinance
There are many advantages to applying for a cash-out refinance. They include:
- Getting a lower interest rate — Mortgage rates are record lows, and you may qualify for a lower rate now than what you got on your current loan. Keep in mind that if you just want a lower rate and don’t need the extra cash, you may prefer to do a traditional refinance.
- Improving your credit score — The money you get from a cash-out refinance can be used to pay off credit card debt. This, in turn, can greatly improve your credit score.
- Consolidating debt — In addition to improving your credit score, using the money to pay off debt can potentially save you thousands in interest payments.
- Deductions on your taxes — If you use the cash to make home improvements, then you may be able to deduct the mortgage interest on your taxes. When in doubt, speak to a tax professional.
Cons of a cash-out refinance
It seems like a cash-out refinance is a home run, yes? While there are many advantages, you should also consider the disadvantages when deciding whether or not to pursue a cash-out refinance. They include:
- Paying for closing costs — Any new loan will require closing costs, which usually run between two and five percent of the mortgage. Calculate these costs and make sure you’re actually saving money before moving forward.
- Paying for private mortgage insurance (PMI) — You’ll be on the hook for PMI payments if you borrow more than 80 percent of the value of your home.
- Risking foreclosure — If you can’t make the payments on your new, bigger loan, then you risk foreclosure.
- Agreeing to new terms — Your new mortgage will have a different interest rate and fees than your current loan. Make sure they work in your favor.
Is it right for you?
Ultimately, you must look at all the pros and cons to determine whether a cash-out refinance is right for your particular situation. Using it to pay for a vacation or enable bad habits like running up credit card debt is not necessarily a good thing. But using it to make upgrades to your home or to pay off old debt can be positive. Be sure you understand the terms before you sign on the dotted line.