A cashout refinance is the process of taking out a new home loan that is larger than your existing mortgage. You receive the difference in cash. The new cash can go toward any sort of financial need, from debt consolidation to funding home improvements. To use a cash-out refinance, you do need to have a certain amount of equity built up in your home.
Ordinary refinancing is different from a cash-out refinance because it simply replaces one mortgage with another loan for the same amount.
* It pays you the difference between the value of your home and the balance of your mortgage.
* It features a slightly higher interest rate due to the larger balance.
* It features a cap on the amount of equity you can extract in cash – typically 80 to 90 percent.
That last point means that you can’t quite convert all of your home’s equity cash. Here is what the process looks like with some numbers: If the value of your home is $200,000 and the balance on your mortgage is $100,000, that means you have $100,000 in equity. Say you have a renovation project in mind that will cost $50,000. If you use a cash-out refinance for $150,000, you’ll receive $50,000 in cash when the deal is done.
Ordinarily, a mortgage refinance offers the lowest possible interest rate, beating out a home equity loan (HEL) or home equity line of credit (HELOC).
In certain circumstances, a cash-out refinance can lower your interest rates as well. If mortgage rates were much higher when you bought your home, a cash out loan can drop your rate. If you bought a house in 2000, for instance, your mortgage rate was probably around nine percent. The average is now much lower than that.
If pulling your interest rate down is your only concern, traditional refinancing remains a better option than a cash-out refinancing. If you need the cash, though …
A cashout refinance can provide enough money to pay off credit cards and other debts. In many cases, this step will save you thousands of dollars in interest charges over the long run.
This goes hand-in-hand with debt consolidation. Using a cash out loan to pay down your debts will reduce your credit utilization (the percentage of your available credit in use). This improves your standing with the credit agencies.
Payments on mortgage interest are, in contrast to credit card interest, tax deductible. Using a cashout refinance to pay off credit card debt will lower your taxable income. That, in turn, could net you a larger tax refund.
As with any form of mortgage, you are using your home as collateral for your cash-out refinance.
A cashout refinance delivers an entirely new loan, and the terms may be quite different compared to your original mortgage. Read the interest provisions and fee details carefully before committing to the deal.
As with any refinance, a cash out refinance obliges you to pay closing costs. Depending on your lender, these can vary between three and six percent of the loan’s full value. On a $200,000 mortgage, for example, closing costs would be between $6,000 and $10,000. Make sure you’re accounting for this added expenses when weighing the potential savings of refinancing.
You may need to pay for private mortgage insurance if you’re borrowing more than 80 percent of your house’s value. If your home is valued at $200,000, for instance, a cash-out refinance for $160,000 will probably require you to pay PMI. Standard PMI costs are between 0.05 to 1 percent of the total loan, paid annually. Insurance at one percent on a $180,000 mortgage, for example, costs $1,800 each year. (You can find more information on PMI here).
If your goal with your cash out refinance is to pay down your credit card debt, you need to exercise discipline with the credit you’re freeing up. Do not build up fresh balances that hurt your financial position again.
It’s well worth considering a cash out refinance if you have a good use in mind for the windfall and you can secure a favorable interest rate. Make sure you put the money toward purposes that will strengthen your financial standing rather than weaken it. This is a good source of funds for debt consolidation or home improvements, not buying a new car or taking a vacation.
Above all else, keep in mind that your house is your collateral in a cash-out refinance. Make your payments promptly to keep your home safe!
Prodigy Lending is a DBA of AmCap Mortgage, Ltd. (NMLS ID# 129122 – www.nmlsconsumeraccess.org/EntityDetails.aspx/COMPANY/129122), an Equal Housing Lender.
Managing RMLO: Jason Turner (NMLS #286357)