Refinancing through cash-out refers to the taking out of a new loan on property that’s already owned by the borrower. The amount of this loan is greater than the existing mortgage, including the latter’s settlement costs. Cash-out refinancing is a great alternative to home equity loans that allows the homeowner to pay a loan and a mortgage simultaneously.
Through cash-out refinancing, your mortgage is refinanced for a bit more than what you currently owe, allowing you to pocket the variation. For instance, imagine that you owe $80,000 over a house that’s worth $150,000, and you wish to seek a lower rate of interest. Also, you need an additional $20,000 in cash, let’s say, to pay off other debts or a college tuition fee, or simply make some improvements at home. Then, you can refinance your mortgage for $100,000. Preferably, you’ll be receiving a superior rate over the $80,000, i.e. the amount that you owe on the home, allowing you to receive $20,000 cash that can be used in accordance to your wishes.
The Difference between Home Equity Loans and Cash-Out Mortgages
You may think that refinancing mortgage with cash-out is rather similar to obtaining a home equity loan, but it’s actually quite different than what most people think. Following are the various ways in which a home equity loan differs from cash-out refinancing:
- A cash-out refinancing mortgage acts as a replacement to your original mortgage whereas a home equity loan is an additional loan obtained on top of the original mortgage.
- This may not happen all the time, but the interest rates fixed over a cash-out refinance mortgage are typically lower than that of the home equity loan.
- Usually, a home equity loan does not require the payment of closing costs whereas cash-out refinancing requires you to pay the closing costs. Also, these closing costs can total up to hundreds or even thousands of dollars.
Refinancing a greater amount at a greater rate does not make that much sense. If your existing mortgage has an interest rate that is lower than what you could obtain at the moment through refinancing, then perhaps it’s better to obtain the home equity loan. According to Nancy Flint-Budde, a Certified Financial Planner working indecently in Salem, N.Y. if you’re pretty far off into a mortgage, i.e. you’ve covered 20 years of a mortgage extending 30 years and you’re paying more principal with every monthly installment than the interest, then refinancing is not an option for you. This is even applicable if your existing rate is a bit higher.
Choosing to Refinance Mortgage with Cash-Out
Prior to searching for lenders to assist you with your refinancing process, think about how much you’re willing to save and what you will do with the extra money. Decide on whether you’re planning to invest the money for short or long term purposes.
If you’re looking forward to paying off your loan along with the extra cash that you’ve picked up through cash-out refinancing within a period of fifteen to thirty years, you should invest the additional money into something that will add more value to your life or home. For instance, you can always start up a new business or use it for medical expenses that are not covered through insurance or simply pay your child’s college tuition fee. Although, if you’re looking forward to spending the summer with your family touring through Europe or planning on buying a new yacht, then it’s probably best to leave the whole cash-out refinance idea at bay as you will be paying for the mortgage for an incredibly long period of time.
Things to Consider
The following points should be considered by a homeowner prior to refinancing:
- The required amount of cash
- The amount you’re going to pay on a monthly basis
- The effect of refinancing over your taxes
- Your break-even point
- The total cost involved in the entre borrowing process
Understanding the advantages and disadvantages associated with cash-out refinance is the key to making the right decision when it comes to managing your household and life expenses.