If you need cash for a good reason and have built up equity in your home, you might consider tapping into that treasure chest of savings that’s hiding under the roof over your head. Cash-out refinancing can allow you to take out a new mortgage for more than your present mortgage balance, pay off your existing mortgage and obtain cash for the difference.
How Does Cash-Out Refinance Work?
Simply put, cash-out refinance is like using your home as a piggy bank. For example, if your home is now worth $200,000 and your mortgage balance is $110,000, you may be able to obtain a new mortgage for $160,000, pay off your old mortgage, and enjoy $50,000 cash to use wisely. Plus you will still have $40,000 equity in your home. Of course, you will be starting over with new payments and terms based on your new mortgage and you will encounter closing costs, so it’s a decision you should consider carefully before signing up.
If your present mortgage is at a much higher interest rate than today’s rates, surprise! You will probably get cash out of your home and enjoy a much lower payment. Cash-out refinancing is most favorable when new interest rates are significantly lower than the rate you are currently paying.
When Should You Consider Cash-Out Refinancing?
What are some good reasons to consider a cash-out refinance? If you have lots of high-interest rate debt such as credit cards, a cash-out refinance can let you lower that interest rate significantly and turn the interest you pay into a tax deduction at the same time. Many types of interest are not deductible, but mortgage interest is. Also paying down your credit cards and other debts can give your credit score a big lift.
Other good reasons for cash-out refinancing could include home improvements, college tuition, medical emergencies and other good investments. Being critical and conservative is necessary when considering a cash-out refinance. Remember that you must be able to pay back the entire debt according to the terms, or you could lose your property.
Cash-Out Refinance Requirements
The process of qualifying for a cash-out refinance is similar to that of a new mortgage. You must meet your lender’s credit, income and loan-to-value criteria and typically you must have 6-12 months of ‘seasoning.’ In this case, that doesn’t mean a big stash of oregano. It means you must have 6-12 months of history on your present mortgage. Also, if you already have a home equity loan or other type of second debt on the home, you must first use your cash out to pay off that debt before any is available to you.
Of course, the specific requirements for your cash-out refi will ultimately depend on which mortgage lender you choose and also which refinance program you select. Today’s cash-out refinance options are generally limited to the following :
- FHA Cash-Out Refinance – up to 85% LTV allowed
- VA Cash-Out Refinance – up to 100% LTV allowed
- Conventional Cash-Out Refinance – up to 85% LTV allowed
If you are nearing the end of your existing mortgage you probably don’t want to refinance, as you are now paying more principal than interest. Or if new interest rates are higher than on your present mortgage, a cash-out refinance is probably not the best way to obtain cash. Other options to get cash for home equity are a home equity loan (sometimes called a second mortgage) and a home equity line of credit (HELOC.) Both of these options typically carry a higher interest rate than a refinance of your primary mortgage, but the up front costs are usually less than the closing costs of refinance.
With a home equity loan you can obtain a fixed sum of cash paid in a lump sum, while a home equity line of credit will provide you with a credit line to tap as you need. Interest on the home equity loan will be calculated on the entire amount while interest on the HELOC will typically be charged only for the amounts and periods you use the funds.
So, if you’re thinking about drawing out cash from the equity in your home, it’s time to get out the calculator, research your options and do the math. It’s comforting to know that the roof over your head also covers your treasure chest, but you should protect that treasure and find the financing option that suits you best. Always use your home equity wisely.