Let’s talk about cash-out refinances.
A cash-out refinance is unique in that it adds a new home loan for more than you owe on your home, which replaces your existing mortgage. The difference between the two is given to you in cash, giving you the ability to use it for things such as debt consolidation, home improvements, or variety of other financial needs.
To use a cash-out refinance, you must have equity built up in your house.
The difference between a cash-out refinance and a traditional refinance is that a traditional refinance replaces your existing mortgage with one of the same balance.
Let’s take a look at how a cash-out refinance works:
- Takes the difference between the mortgage balance and the value of the home and pays out
- Higher loan amount creates slightly higher interest rates
- Cash-out amounts are limited to 80% to 90% of your home equity
This means that you cannot pull out 100% of your home’s equity.
For example, if your home has a $300,000 value and your mortgage balance is $150,000, this means that you have $150,000 worth of equity in your home. You could then refinance your $150,000 loan balance for $200,000 and use your $50,000 for the things listed above.
Advantages of a Cash-Out Refinance
You may end up with a lower interest rate on a cash-out refinance today in the case that you purchase your home when mortgage rates were higher. Rates are considerably lower today than they were back in 2000. Of course, regular refinancing makes more sense if you want to lower your interest rate without the cash.
Here are some of the advantages of a cash-out refinance:
- Build Your Credit Score: You can build your credit score by paying off your credit cards with a cash-out refinance, which will help to reduce your credit utilization ratio.
- Debt Consolidation: You can pay off high-interest credit cards with cash-out refinance money, which could save you thousands in interest
- Tax Deduction: A cash-out refinance could provide you with a mortgage interest deduction if you use the money to improve your home
Disadvantages of a Cash-Out Refinance
- Foreclosure: You risk losing your home if you are unable to make the payments on it, as your home becomes collateral for any type of mortgage.
- Closing Costs: You have to pay closing costs on a cash-out refinance, which can be anywhere from 2%-5% of the overall mortgage. If you’re paying that on a $300,000 loan, you could be looking at anywhere from $6,000-$15,000. You’ll want to make sure that your potential savings justify the cost.
Final Verdict – Is A Cash-Out Refinance Right For You?
If you can get a good interest rate on a new loan and you have a good use for the money you will receive, a cash-out refinance can be an excellent idea. Of course, you don’t want to use this money to simply go on vacation or buy a new car, as you won’t receive any return on investment.
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