What Is a Cash-Out Refinance?
A cash-out refinance is a type of mortgage refinancing that allows homeowners to tap into their home equity and convert it into cash. This involves taking a new mortgage for an amount greater than your existing mortgage, with the difference paid to you in cash.
By opting for refinancing in general, you can often obtain more favorable loan terms, such as lower interest rates, reduced monthly payments, or extending/shortening the loan duration. In a cash-out refinance scenario, you specifically benefit from accessing cash rooted in your home’s equity.
Key Takeaways
- In a cash-out refinance, the new mortgage replaces the existing one and covers a larger amount, with the difference disbursed in cash.
- Such refinances usually come with higher interest rates or more points compared to a rate-and-term refinance.
- The amount available for cash-out is determined by the lender based on your property’s loan-to-value (LTV) ratio and your credit profile.
How a Cash-Out Refinance Works
Using a cash-out refinance, you leverage your home as collateral to secure new loan terms alongside receiving some cash. This helps cover various needs like emergencies or significant expenses.
Borrowers begin by finding a willing lender, who reviews the current mortgage terms, the amount required to close the existing loan, and the borrower’s credit worthiness. Upon approval, the new loan repays the original mortgage and the balance is provided in cash to the borrower.
The end result gives you liquid capital that could be used to pay large bills, consolidate debts, or as a financial cushion. Because your home is providing this cash, closing costs, fees, or interest for a cash-out refinance can be higher as compared to other refinancing options.
Lenders typically cap the loan amount for cash-out refinancing at 80% of your home’s equity.
Example of a Cash-Out Refinance
Suppose you currently have a mortgage balance of $100,000 against a house valued at $300,000. This gives you $200,000 in home equity. You decide to go for a cash-out refinance, and your lender agrees to refinance 75% of your home’s value, equal to $225,000. Out of this amount, $100,000 will pay off the existing mortgage, leaving you with $125,000 in cash.
If you need only $50,000 in cash, you refinance for $150,000 covering the remaining loan amount and the cash portion. The new mortgage rate and term could potentially be improved.
Pros and Cons of a Cash-Out Refinance
Pros:
- Access to Cash: Get ready capital for significant expenses.
- Lower Interest Rates: Beneficial especially when compared to credit cards or personal loans.
- Debt Consolidation: Using funds to pay off high-interest debts.
Cons:
- Increased Risk: Higher risk of losing your home if you default or home value drops.
- Costs and Fees: Higher closing costs and fees compared to standard refinancing options.
Consider carefully if a cash-out refinance suits your financial situation. If consolidating consumer debt, aim for financial control to avoid falling back into debt.
Cash-Out Refinance vs. Home Equity Loan
With cash-out refinance, you create a new mortgage replacing your existing one, drawing cash in the process. A home equity loan, on the other hand, serves as a second mortgage with separate liens, meaning two creditors may have claims on your home. Generally, home equity loans have lower closing costs.
In conclusion, both refinancing options have their merits and depend upon individual financial needs and long-term plans.
Manage your finances wisely and explore all options when considering loan adjustments, refinances, or equity liquidation to ensure favorable outcomes.
Related Terms: home equity loan, home equity line of credit (HELOC), cash-out refinancing, rate-and-term refinance.
References
- Experian. “What Is a Cash-Out Refinance?”
- U.S. Department of Veterans Affairs. “Cash-Out Refinance Loan”.
- USA.gov. “Mortgages”.
- Consumer Financial Protection Bureau. “Should I Refinance?”
- Federal Reserve Board. “A Consumer’s Guide to Mortgage Refinancings”.
