A cash out refinance is a transaction where the borrowers take out equity in the form of cash while refinancing an existing mortgage. Homeowners who financed their homes have the opportunity to refinance an existing mortgage for a variety of reasons and it’s not only because interest rates are lower than the one they currently have but for most, that is the primary driver. There is no reason to not refinance to a lower rate should a lower rate become available and the process of refinancing is very much like taking out the original loan.
Say that a borrower has an interest rate of 5.00% on a 30 year note and rates have fallen to 4.00%. By refinancing to the lower rate, the borrower saves on interest. Or, the borrower could elect to change from a 30 year note to a shorter term loan. Doing so saves on long term interest and the loan is paid down at a quicker pace. And refinancing from an adjustable rate loan or a hybrid is also a good option for many borrowers who want to get away from the uncertainty of a rate that can adjust into a fixed rate that will never adjust.
Refinancing just the original loan along with the associated closing costs, lenders refer to this process as a “rate and term” refinance where the rate, loan term or both are changed. A cash out refinance also changes the rate and term but in addition to paying off the old mortgage and closing costs the borrowers receive cash at the closing table either with a cashier’s check or wired directly into their bank account.
Borrowers taking out a cash out refinance can use the cash proceeds for any reason at all and there are no restrictions as to the use of the funds. Paying off credit card balances, home improvements, taking a vacation or paying for college can be reasons for taking out cash. Plus, the interest on a cash out refinance is so much lower when compared to any other borrowing that it can make good financial sense to pay off higher interest debt with lower interest debt.
Taking out cash means tapping into your equity so make sure a cash out refinance fits in your financial planning picture. If you’re satisfied with your current mortgage and happy with your rate but you still want some extra cash, then a home equity line of credit or second mortgage might be a better option. But if you are considering refinancing to a better mortgage, you do have the option of taking out cash during the process.