Cash-Out Refinance Pros and Cons
Cash-out refinance loans allow you as a homeowner to replace your existing home mortgage loan with a new one for a larger amount, allowing you to “cash-out” on the difference by receiving a lump sum that can be destined for a variety of purposes. These types of loans can allow you to convert part of your home’s equity into readily-available liquid funds. New mortgages might have different interest rates and terms. They might also result in a shift from an adjustable-rate plan to a fixed-rate one, or vice versa.
What is a Cash-out Refinance Loan
A cash-out refinance loan can be explained through the following example: On a $350,000 home where the owner currently owes $200,000 of their first mortgage and would like to get $50,000 in liquid cash, a new loan can be taken for $250,000. This would pay off the $200,000 debt on the initial mortgage, providing an additional $50,000 in cash. For the cash-out refinance to make sense, the second loan must have a lower interest rate than the first one. However, other factors should be taken into consideration as well, such as eventual tax benefits, debt consolidation benefits, and eventual closing costs involved.
This type of refinance loans should be considered when they allow the beneficiary to improve the terms of their first mortgage. If you currently have credit card debt, a cash-out refinance might allow you to roll it into your mortgage if you have enough equity to do so and pay it all off at once, helping improve your credit score by getting rid of your consumer debt. This might lower your interest rates as well, and in many cases, monthly payments can hardly be affected by the change as long as the interest rate on the new loan is lower than the first one. This kind of debt consolidation cash-out refinance allows you to get tax benefits as well since the mortgage interest on the cash-out refinance is tax-deductible (as opposed to credit card interest rates, which are not). An added benefit of cash-out refinance loans is their steady interest rates, which allows for predictability of the mortgage payment amounts.
Things to Consider about Cash-Out Refinance Loans
Although they might sound like a great way to get fast cash while improving mortgage terms, cash-out refinance loans are not always the best way to go as they can add a risk factor to your current mortgage situation by increasing your debt amount and payment term. If your first mortgage has good terms but you want to refinance it to do home renovation work, for example, there are cases in which it would be more convenient to get a home equity line of credit instead of refinancing your current home mortgage loan. Additionally, your credit score can affect the offered interest rate on a cash-out refinance loan, resulting in higher interests, even if your home meets the LTV ratio requirements for the loan. Normally, taking on a cash-out refinance loan is not recommended when the interest rate on the second loan would be higher than on the first one. Closing costs should also be taken into consideration: although these are not involved when taking a home equity loan, when cash-out refinance is required you will have to pay closing costs for the refinanced mortgage.
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