A cash-out refinance is nothing more than pulling out equity in the form of cash while refinancing an existing mortgage. Yet some may wonder if taking out equity is a good idea and if so, when does a cash out refinance make sense?
There are three primary reasons for someone to refinance an existing mortgage. One is to obtain a lower rate and reduce the monthly payments. The second is to change the loan term to reduce the amount of interest paid to the lender over the life of the loan and the third is to refinance out of an unstable adjustable rate or hybrid mortgage into the stability of a fixed rate loan. A refinance in any of these scenarios can make sense and by reviewing your current situation and speaking with a loan officer, you might be ready to refinance your current loan, especially as rates continue to stay relatively low. But taking out cash?
When you take out cash you’re tapping into your current equity. If all you want is some money to remodel your kitchen and you want $10,000, then perhaps a home equity line of credit or HELOC is your better option. These are second liens that subordinate to your existing mortgage. Rates will be slightly higher than for a first loan but the closing costs are almost non-existent. If your current mortgage is fine and you’re happy with your rate and term but you want extra funds, a HELOC is your choice.
However, during the course of a refinance to lower your rate and you have extra equity you can tap into, perhaps taking out that extra $10,000 in addition to lowering your monthly payment with a refinance makes financial sense. Funds from a cash out refinance can be used for most anything on your wish list. A remodel, college education or paying off an automobile loan or credit cards. Pulling out cash to pay off existing debt can lower your overall monthly payments. Just know that the amount borrowed will be paid off over the entire term of the loan and even though the overall monthly payment are lower, long term interest will still be an issue. And once credit cards are paid off, keep the balance at zero or otherwise make sure you don’t run up your credit card balance once again.
A cash out refinance is really something that is a secondary consideration and should not be taken out just to access extra cash. There are better options for that scenario. However, if you are considering refinancing your existing loan, talk to your loan officer about cash out options.