Need more space in your home or your budget? Consider a cash-out refi.
Looking at the typical real estate headlines right now can be pretty confusing:
“Low rates mean now is a good time to buy”
“Record low housing inventory leaves eager homebuyers with few options”
“Economic uncertainty due to the pandemic keeps many buyers on the sidelines”
Those are just examples, but who could blame you if you’re not sure to buy, sell or just sit back and wait for the world to return to normal?
You do have a mortgage option that could help you navigate this difficult time. And it can help you whether you’re thinking about changing your living arrangements or simply managing your finances until the economy picks back up.
It’s called a cash-out refinance
A cash-out refinance is a way to refinance your current mortgage for more than the amount owed. You take the difference in cash. While you may be able to use it to lower your rate and adjust the terms of your loan, the primary purpose of a cash-out refi is to convert home equity into liquid assets.
It lets you take advantage of current market rates and keep one mortgage loan. If your home is worth more than you owe on your existing mortgage, you may be able to pull out equity and secure a lower interest rate. The tradeoff? A larger loan amount and a prolonged loan amortization.
While a typical mortgage refinance alters the rate and term of your mortgage, a cash-out refinance increases the actual amount borrowed. You are then able to pay off your existing mortgage entirely (and thus can continue paying your mortgage off to your new creditor at the same rate and term or an altered one) while receiving a lump cash sum for the increased amount borrowed. Hence the name, “cash-out refinance.”
Reasons for refinancing:
Take control of your debt
The economic fallout of the pandemic is one of the most notable aspects of the last year. Many people have lost jobs, or just seen their work furloughed for stretches in 2020. A cash-out refinance is one way to get a little more money in hand, which you can use to consolidate bills and eliminate high-interest charges. The benefits of this approach include:
- Fixed payments: Eliminate differing due dates and various companies you owe to, putting all your loans and debt into one recurring payment.
- Steady interest rates: With rates still pretty low right now, you could capitalize on market conditions and lower your monthly payment.
This approach works great for:
1. Credit card debt
Credit cards usually have a higher interest rate than your mortgage, which means your debt to the credit card company is going to cost you more than a similar amount of debt to a mortgage provider.* You could use the cash from a cash-out refinance to pay down your credit card debt, making it less expensive.
2. Medical bills
Instead of paying interest on healthcare bills to possibly many entities, you could pay them back with the money from a cash-out refi. Then you’ll only have to pay a single bill, your mortgage, going forward. And again, the rates on a mortgage are likely less than the interest on those medical bills.
3. Essential investments, like a vehicle
Large investments that improve your life and work are an efficient use of your money. The benefits you’ll reap in terms of your earning potential and quality of life are well worth the money you’ll spend. A great example is a car.
If you live in a big city with good public transit, you may not need one, but if you live outside a city, it might be impossible to live without it, and a cash-out refi is a useful tool to help you make that investment.
Renovating your home
At this point in the pandemic, when we’ve all been stuck in our homes for long stretches of time, many people are beginning to look at their space and deciding they need something new. Some are looking to buy new homes but are getting frustrated because there is a historically low number of homes for sale. So, people are turning to renovations to make more space for work and family in their homes. They’re taking the space that might have worked before the pandemic changed how we live in our homes, and making it work in the new normal.
A cash-out refi is a great option for securing the funds for that big project, especially with rates still pretty low. And this project doesn’t just improve the comfort of your home, it can add resale value. Some great ideas include finishing your basement, expanding a tiny kitchen or building up into an attic to create more room.
How does a cash-out refinance work?
It’s important to know that your ability to undergo a cash-out refinance depends greatly on your home equity. If the assessed value of your house is higher than the principal amount left to pay on your mortgage, you have home equity. You generally need at least 20% equity in the property in order to be eligible to qualify for a cash-out refinance.
How much equity do you have?
Home equity is the difference between how much your home is worth and how much you still owe on your mortgage. You’ll want to make sure you have enough equity built up so that your cash-out refi won’t increase your loan-to-value (LTV) ratio to over 80%. When your ratio exceeds this amount, you may need to purchase mortgage insurance.
Let’s say you bought a home for $200,000 with a down payment option of $20,000. Five years down the road, you’ve paid off $13,000 of your mortgage and owe $167,000 while your home’s value has increased to $220,000. To determine your equity, take your home’s current value ($220,000) and subtract the amount that’s still owed ($167,000) – in this case, your home equity would be $53,000.
Then, divide $53,000 by the $220,000 value and you have over 24% home equity, which could make you eligible to qualify for a cash-out refinance (speak to your licensed Loan Officer to confirm).*
Should you do a cash-out refi?
There are risks associated with a cash-out refinance. If you take on a larger mortgage and have a hard time keeping up with your payments, you could risk losing your home. But if you can swing those higher payments, a cash-out refinance could help you meet other important money-related goals.
Cash-out Refi Pros
From home improvements to financial investments, a cash-out refinance can give you the means to upgrade your home and set up a future nest egg. Wise planning can increase your home’s value and build equity down the line.
As we’ve covered above, a cash-out refi can be used to consolidate loans, bills, debts and other necessary expenses that may be holding you back financially. And it makes it simpler for you to manage, as you’ll only be paying one new mortgage loans, instead of a mailbox-full of bills.
Steady interest rates:
With the right timing, you could capitalize on market conditions and knock down your monthly payment. In general, cash-out refinancing offers lower interest rates than personal loans. They also feature consistent payments—perfect for ongoing home renovations.
Cash-out Refi Cons
Higher rates than other refinances:
Because you refinance for more than the amount owed, cash-out refis are innately more risky than traditional rate and term refi products. This means they could come with a slightly higher interest rate than the baseline.
Anytime you refinance, you go through the closing process and all the costs and fees that go along with that. With a cash-out refi, you’ll also need to pay interest on the chunk of change you pull out of your mortgage.
Keep in mind—the more equity you take out of your home, the more risk you add if money gets tight or the property value decreases. It’s unwise to drain your equity for vacations or other superfluous purchases. Your home isn’t a piggy bank!
While a cash-out refi can help you consolidate unsecured high-interest debt, this strategy essentially raises the stakes. Using your mortgage to consolidate debt means your home becomes the collateral. If anything happens and you can’t make your payments, the lender can foreclose on your home. Don’t bite off more than you can chew!
If you're not sure how much of a monthly payment you can handle, you can use our mortgage calculator to run the numbers by putting in your desired loan amount. In this case, remember to use your existing mortgage balance plus the amount you'd be looking to take out in cash, its term and the interest rate you think you'll get. Here's a snapshot of what refinance rates look like today. Having that information will help you decide whether a cash-out refinance is right for you.
* Savings, if any, vary based on consumer’s credit profile, interest rate availability, and other factors. Contact Proper Rate, Inc. for current rates. Restrictions apply.
Applicant subject to credit and underwriting approval. Not all applicants will be approved for financing. Receipt of application does not represent an approval for financing or interest rate guarantee. Restrictions may apply, contact Proper Rate for current rates and for more information. All information provided in this publication is for informational and educational purposes only, and in no way is any of the content contained herein to be construed as financial, investment, or legal advice or instruction. Proper Rate, Inc. does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Some information in the publication may have been provided by third parties and has not necessarily been verified by Proper Rate, Inc. Proper Rate, Inc. its affiliates and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action. *Proper Rate does not provide tax advice. Please contact your tax adviser for any tax related questions.
Using funds from a Cash-out Refinance to consolidate debt may result in the debt taking longer to pay off as it will be combined with borrower’s mortgage principal amount and will be paid off over the full loan term. Applicant subject to credit and underwriting approval. Restrictions apply. Contact Proper Rate for more information.