A cash-out mortgage refinance refers to a refinancing arrangement where one borrows more than their current loan. They get the difference between the two amounts in cash. This is usually done in order to turn some of the equity accumulated on the home into cash.
Cost
A cash-out refinance is similar to a conventional one in that the borrower has to foot the closing costs. These could amount to hundreds or even thousands of dollars. One also has to pay interest on the cash they get out in addition to the mortgage amount. Again, this could add up to thousands of dollars over the loan’s lifetime.
What’s the Cash Used for?
Typically, the cash can be channeled into any use that the borrower prefers. This could range from settling a credit card debt to going on holiday. In practice, some uses of this cash are more prudent when compared to others.
If one has a high interest debt, such as credit cards, it would make sense using a cash-out refinance to pay off this amount. All costs need to be taken into account before taking this option. This is because in most cases, interest payable for credit cards usually exceeds that of the new loan considerably.
In doing this, other benefits can be realized. The borrower could boost their credit score by paying out the maxed-out credit cards. There’s also a benefit that applies in shifting the credit card debt to a home loan because the interest can be deducted from taxes.
This money could also be channeled towards home improvements, which could boost its value in the long run. One however needs to be aware of the risks involved. If the new loan isn’t repaid, one could end up losing their house.
Restrictions of Such a Refinance
Most lenders won’t consider borrowers in certain financial situations for a cash-out refinance. Some of these include having a minimum credit score (this is usually higher than that of a conventional refinance). People who’ve owned their houses for at least one year and have a loan-to-value ratio of not more than 85%. The loan-to-value ratio is the total borrowed amount divided by the home’s appraised value.
Other Alternatives
Due to the costs that come with such an arrangement, one could consider other options such as a home equity line of credit or a home equity loan. Unlike a cash-out arrangement, these are taken out separately from the loan one already has. Under a home equity line of credit, the house is used as collateral. One could withdraw money from the line of credit whenever necessary, up to a specific amount. The interest rate is usually adjustable.
A home equity loan is a separate loan on top of the existing one where the money is given as a lump sum. Again, the house is used as collateral. The interest rates are usually fixed.
To pick the best option, one needs to consider their needs. If the money is needed in a lump sum, a home equity loan would work. Other vital considerations include fees, total interest payable and closing costs. Though cash-out refinances have lower interest rates than the two alternatives, the closing costs tend to be higher. In addition, they also reset the term of the loan, so one ends up paying more interest in the long run.
A cash-out mortgage refinance would be worth pursuing if one can get a good interest rate and knows how they can quickly repay the loan. If there are any concerns about repayment, then it wouldn’t be worth it. One could consult a financial expert on the best course of action to take.