As home prices go up, homeowners have access to more equity, and many are putting it to good use.
A cash-out refi is a way to refinance your current mortgage and borrow money at the same time. It means you’ll change the interest rate and payment on your mortgage and receive a check at closing. The balance owed on your new mortgage will be higher than your old one by the amount of the cash you receive plus any closing costs rolled into the loan.
There are no restrictions on how you use the proceeds from a cash-out refinance–you can use the money to pay off debt, toward education costs, home improvements, to start a business or to cover medical expenses, for example. You could even use it to take a vacation!
Cash-out refinancing and home equity
To qualify for a cash-out refinance, you need to have a certain amount of equity in your home—you’ll be borrowing against your home’s equity.
Let’s say, for example, your home is worth $350,000 and you currently owe $200,000 on your mortgage. You have $150,000 in home equity, or 43 percent of the home’s value.
In general, lenders will allow you to refinance up to 80% of your home’s value. In our example above, you’d be able to borrow up to $80,000.
To borrow that amount, you would take out a new mortgage for $280,000 ($200,000 already owed plus $80,000) and receive a $80,000 check at closing. Keep in mind that this amount doesn’t take into account your closing costs, which can be around 5 percent of the loan amount and are usually rolled into the mortgage, so your cash at closing would be $80,000, less closing costs.
In addition, you’ll need to be able to qualify for the new loan amount—your debt-to-income ratios and credit score need to meet the same criteria for purchasing a home at that amount.
Advantages of cash-out refinancing
- Mortgage rates tend to be lower than the interest rates on other types of debt
- Using cash to pay off other debts can lower your overall monthly payments and boost your credit
- Mortgage debt can be repaid over a considerably longer period than other types of debt, up to 30 years, so it can make your payments more manageable
- If market rates have dropped since you took out your mortgage, a cash-out refinance can let you borrow money and reduce your mortgage rate at the same time.
Disadvantages of cash-out refinancing
While a cash our refinance can be great for lowering your payment and getting the cash you need today, it means increasing your mortgage amount, and sometimes extending your mortgage terms (potentially back to 30 years).
On a cash-out refinance you’ll pay closing costs on the entire loan amount. So, if you owe $2000,000 on your mortgage and use a cash-out refinance to borrow another $80,000, you’re paying closing costs of up to 5 percent on the new loan amount: the entire $280,000.
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