Cash-out refinancing is a tool used by property owners to receive cash. Whoever is paying a mortgage requests this new loan for a larger amount of money than what is currently owed on their home.
The difference between the two amounts is because the first one responds to the cash closing, while you can invest in home improvements or pay off debts with the second one.
With this money, you can pay off old debts or use it in a financial emergency. But you should consider that you now owe a larger amount of loan with different terms; for this reason, it is important to know the aspects of this new loan to determine if a cash-out refinance is a good idea.
What is cash-out refinancing?
A cash-out refinance is an amount of money that replaces your current mortgage with a larger one. You receive the difference in cash between the old loan and the new one, and you can use the money as you wish. According to statistics, the usual reasons for which this money is requested are:
- 40% request it to pay off debts
- 31% to invest in home repairs and remodeling
- 14% to increase cash savings
- 9% to buy a new car
- 7% to pay for children’s college
- Some homeowners use it for more than one reason
The “cash-out refinance” is the amount of money left between your current and previous mortgage. The amount of money you receive depends on the equity in your home; that is, how much your home is worth compared to how much you owe.
To give you an example, your home is valued at $300,000, and you owe on your mortgage $200,000, which means there is $100,000 of cash invested in the home. So, you can refinance the $200,000 for $250,000 to receive $50,000 cash at closing. The amount you can borrow with the refinance depends greatly on how much you pay.
Pros and cons of cash-out refinance
Like any action, asking for a refinance has its advantages and disadvantages. Depending on your case, you must consider the following:
Advantages
If you are wondering what the benefits of a cash-out refinance are, read about them here-below:
- Low-interest rates: Refinancing rates are usually higher than loans for purchase, but you can have a lower rate if the interest on the original mortgage has increased
- It’s a loan: You will pay in easy monthly installments the price of your loan
- Access to money: It is essential for emergencies or to cover necessary expenses such as paying for college or remodeling your home
- Closing a debit: Applying for a loan allows you to get out of debt, simplify your delinquencies, and save thousands of dollars in interest
- High credit score: Paying off your credit card with a refinance increases your credit points
Disadvantages
The most common disadvantages are:
- Foreclosure risks: your home is the collateral for any default; by taking out an additional loan, you risk losing it if you default on payments. If you ask to refinance to pay for college, you will pay off the unsecured debt with the secured debt.
- New terms: This new loan has a different duration than the old loan. We recommend you review the interest rates and fees before agreeing
- Waste of time: If you need the money urgently, this is not a viable option because it takes weeks to complete the process and receive the money
- Closing costs: Typically, two to five percent of the loan
- Private mortgage insurance: If you receive more than 80% of the property’s value, you must pay for private mortgage insurance
Is it a good idea to do a cash-out refinance?
Cash-out refinancing can be a good idea in some cases and a lousy one in others. Mortgages have lower interest rates than other loans. In other words, this is one of the cheapest ways to pay for large expenses such as college tuition or invest in a new company.
But if you are applying for a refinance to pay for a vacation or buying a car, it is not a good idea. These are expenses, not investments, because you will receive little or none of this money.
It is important to evaluate your main reasons for requesting it and ensure that you can maintain the ongoing monthly payment in the future. Remember that the danger of missing monthly payments is that you could lose your home. We advise you to talk to a financial expert to find out if this is a good idea.
Cash-out refinance calculator
One of the most frequently asked questions among interested parties is how much money you can receive from a refinance. To do the calculation, you should consider the following things:
- How much is your home worth? Actual value of the property
- How much do you owe on your mortgage? Mortgage balance
- How much money does the lender need for you to receive after refinancing? Retained Equity
Lenders often use a physical rate or an automated valuation model. They compare this data based on a schedule of similar properties to define how much your home is worth. The recipient can borrow 80% of the home’s value or up to 90%, if the lender allows it.
The result of this new amount is subtracted from what is owed on the mortgage, and you will receive the remaining amount in cash.
However, you do not have to withdraw the total amount allowed; you can also ask for a lower percentage than the one offered. It is important to know that this payment is not taxable because it is not an income but a loan.