Refinancing your home or other property is not just to acquire more favorable loan terms than your current mortgage. Some forms of refinancing, such as cash-out refinancing, allow you to obtain a second loan, a possible boon if you want to improve your property.
With a cash-out refi, you can borrow more than the balance left on your existing mortgage when you refinance. You can then use the extra cash received from the higher loan amount to fund home renovations, pay off debts or make major purchases.
Cash-out refi in action
To take a basic cash-out refi scenario, say a homeowner owes $200,000 on their current mortgage but their home is worth $300,000. If they refinance for $240,000, the first $200,000 pays off the old mortgage, and they receive the extra $40,000 in cash. To qualify for a cash-out refinance, the homeowner needs sufficient equity in their home and good credit.
The positives of a cash-out refi
Cash-out refinancing can be advantageous because it allows homeowners to tap into their home equity and take out a large loan at a low-interest rate. Mortgage rates are often much lower than rates for other types of loans like home equity loans or lines of credit. This can make cash-out refinancing an affordable borrowing option.
When cash-out refi presents problems
However, there are risks to consider. Monthly mortgage payments may increase even if the interest rate decreases because the loan amount rises. Higher monthly payments could become unaffordable over time, raising the risk of foreclosure. Tapping home equity also decreases the equity cushion that protects against owing more on a mortgage than the home is worth.
In addition, cash-out refinancing leads to higher closing costs since it is a larger loan. Homeowners should shop around to find the best rates and fees. Using an online mortgage calculator can help determine if the new monthly payment is manageable.
Overall, cash-out refinancing can be a reasonable choice if the homeowner needs to fund major expenses and can qualify for competitive rates and terms. Still, proceeding with caution is wise, as taking on additional debt secured by a home comes with inherent risk. Homeowners should carefully evaluate their budget to be sure the higher payments are sustainable for the long haul.