If you’ve thought about exploring a cash-out refinance, it’s a good idea to weigh the pros and cons. Using cash-out refinancing for home improvements is often a good strategy, but using it for other things could put your home at risk. Let’s dive in and see the benefits and downsides of this refinancing option.
What Is a Cash-Out Refinance?
When you get a cash-out refinance, you replace your current mortgage with a new home loan that is more than you owe on your mortgage. The difference between what you use to pay off your home and what is left is money you can use for other financial needs, such as debt consolidation, home improvements, and any other financial needs you may have.
Cash-out refinancing differs from traditional financing because traditional financing replaces your existing mortgage with a new mortgage with the same balance.
How Does a Cash-Out Refinance Work?
To qualify for a cash-out refinance, you have to have equity in your home. Here’s a breakdown of how cash-out refinancing works.
- Cash-out refinancing pays a part of the difference between the home’s value and the mortgage balance.
- This type of financing has slightly higher interest rates because the loan amount is higher.
- Cash-out refinancing amounts are limited to 80% to 90% of the equity you have built up in your home.
To clarify, you can’t pull out all of your home’s equity. For example, if your home’s value is $300,000 and your mortgage balance is $150,000, you have $150,000 of equity built up in your home. With cash-out refinancing, you can refinance the $150,000 mortgage balance for $200,000 and receive $50,000 in cash when you close. Then, you can use that money for home renovations that will increase the value of your home.
Are There Benefits of a Cash-Out Refinance?
Here are some of the benefits of cash-out refinancing.
Lower Interest Rates
When you refinance a mortgage, you will typically receive a lower interest rate than you would get with a home equity loan or a home equity line of credit.
If you bought your home when mortgage rates were higher, you may get a lower interest rate when you refinance.
Consolidation of Debt
People who have significant credit card debt can save thousands of dollars in interest if they’re using a cash-out refinance for debt consolidation.
Higher Credit Score
When you pay off your credit cards with a cash-out refinance, you can build your credit score. The reason for this is that when you pay off your credit cards in full, you reduce your credit utilization ratio, which is the amount of credit available to you.
Tax Deductions
If you use the money from your cash-out refinance to make home improvements or build onto your home, you may be eligible for a mortgage interest deduction.
What Are the Drawbacks of a Cash-Out Refinance?
While there are multiple benefits of cash-out refinancing, this option isn’t without drawbacks.
New Terms
A new mortgage will have terms that are different from your original mortgage.
Closing Costs
With a cash-out refinance, you pay closing costs just as you do with any type of refinancing.
Private Mortgage Insurance Costs
Borrowing more than 80% of the value of your home will require you to pay for private mortgage insurance (PMI).
Foreclosure Risk
When you opt for a cash-out refinance, you are using your home as collateral. As with any kind of mortgage, you run the risk of losing your home if you fail to make the payments.
Final Thoughts on Cash-Out Refinancing
If you can manage to get a good interest rate, a cash-out refinance may make sense for you. This is especially true if there’s something important you need the money for.
Seeking a cash-out refinance to fund a new car or family vacation isn’t the most responsible idea because it gives you minimal return for your money. However, cash-out refinancing can make a lot of sense for funding a home renovation or consolidating debt.
If you are a current homeowner in Cape Coral, Florida, and are considering refinancing your home, get in touch with Cape Coral Mortgage today. We have more than 20 years of combined experience in the mortgage industry, and our team is here to help you explore your options.
