Buying and financing your home can be confusing. There are plenty of options for financing and refinancing a home purchase.
Once you're a homeowner and you've built some equity, there are many ways to refinance your home or use your home's equity to your financial advantage.
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Have you heard of a cash-out mortgage? A cash-out refinance could be a good idea if you need cash for a home improvement renovation or to consolidate debt. Consolidating your debt via your home equity often allows you to have a lower monthly outgo, than paying your debts individually. Here's your complete guide to everything you should know about a cash-out refinance.
What is a Cash-Out Refinance?
You've probably heard of the idea of refinancing your home. When done the right way, a mortgage refinance can get you a lower interest rate and reduce your monthly payments.
With a cash-out refinance, you add more money to your loan amount. In return, you get cashback to use in whatever way you need.
- You can still reduce your interest rate when refinancing as a cash-out loan. Current interest rates could be lower than the terms of your original home loan.
- The difference between your current loan amount and the amount of your newly refinanced loan comes to you in cash.
- The result is a new mortgage that covers the balance you have left to pay on your home plus the "cashed out" payment you received.
A cash-out refinance is a good decision for many homeowners, but it's not for everyone at every moment. We'll talk more about why people choose to refinance with a cash-out loan, and if it's right for you.
Cash-Out Refinancing is Not a HELOC
You might think a cash-out refinance is the same as a HELOC (Home Equity Line of Credit). While the idea of using your home's equity for funds is similar between the two, a cash-out refinance is not the same as a HELOC.
Although you can refinance your mortgage loan and replace it with a HELOC in some circumstances. At least with lower balance loans.
With a HELOC, you have a line of credit that's available as you need it. It's not a one-time lump sum of cash like a cash-out refinance mortgage.
HELOCs can come with timeframes that limit how long you can draw cash. Since it's a line of credit, you repay the full amount that you draw as credit. HELOCs are also variable rate, just like your credit cards. They are typically used as a second mortgage.
What Can I Do With a Cash-Out Refinance?
A cash-out refinance is ideal for many things. Since it's cash, you can use it as you see fit.
Many people use this tool to:
- Fund renovations on their home and improve the home's value
- Pay off high-interest credit cards
- Eliminate other debt to save on monthly expenses
- Help fund a child's college education
- Pay for unexpected medical emergencies
- Withdraw capital to invest in other things or properties
- Extract equity gains while values are high
Since a cash-out refinance uses your home as collateral, you want to be careful how you use your funds. Buying a new car or going on a shopping spree or vacation isn't a responsible way to use the cash funds provided by your new mortgage.
Is it Too Good to be True?
As mentioned above, a cash-out refinance isn't for everyone. There are plenty of pros to refinancing your home this way. There are also some cons to consider before applying for a cash-out refinance.
The Pros
When you're approved for a cash-out refinance, you'll see some benefits beyond the cash payment.
- Improve Your Credit Score—If you use your funds to pay off high-interest rate credit cards or eliminate other debt, you'll probably see an improvement in your credit score. This is an excellent use for cash-out refinance funds.
- Lower Interest Rates—Depending on when you bought your home, interest rates are generally lower than they were a decade or more ago. Chances are, your refinanced rate will save you some money from interest on the loan.
- Tax Deductions—Your newly refinanced loan may come with tax-deductible mortgage interest.
- Improve Your Home's Value—If you use your cashed-out funds to make a thoughtful upgrade to your home, you'll improve your home's value. When it comes time to sell the house, down the road, you're more likely to recover more of your investment.
When used the right way, your cash-out refinance can not only fund a renovation or help reduce your debt, you're likely to experience other financial benefits.
The Cons
As with any financial decision, there are some points to consider before signing on the dotted line.
- Perpetuating Bad Habits—Don't use a cash-out refinance to support bad spending habits. Digging yourself out of one mountain of debt with your cashed-out amount, only to build another mountain, is one big reason not to go for a cash-out refinance. Remove debt that's a burden, then work hard to stay debt-free.
- Closing Costs—As with any mortgage, you'll pay closing costs again when refinancing your home loan. This amount can be financed and rolled into your monthly mortgage payments, but be sure the closing costs are worth any savings you hope to gain from the refinance.
- New Loan Terms—Be sure you are familiar with the new terms of your loan before you finalize it. Chances are, the terms are different than your original mortgage. Review payment due dates, rates, fees, early payment penalties, and the new length of your loan.
- Private Mortgage Insurance—Unless you're refinancing to less than 80% of your home's value, your refinanced loan may include private mortgage insurance.
It's critical to understand your reasons for refinancing your home with a cash-out option before you go through the process of approval and ultimately close on a new mortgage. Your cashed-out amount isn't a new stash of spending money to be blown too lightly.
Use the funds to add value to your home, strengthen your overall financial position, or relieve overwhelming debt.
What Else Do I Need to Know?
As with other loans, a cash-out refinance comes with criteria and other considerations. Not every homeowner qualifies for this type of refinance, and not every home is a good candidate for cash-out refinancing.
Be sure you do your research to know what to expect and the cash-out refinance rules.
- How much equity do you have in the home? In general, your home can qualify for a cash-out refinance if you have at least 20% equity.
- How much can I borrow? The refinanced amount will pay off the original remaining loan amount plus give you the remaining amount in cash. 80% of your property value is a could number, while retaining a good equity cushion. Though there are some loan programs which may allow you to borrow up to 150% of your home's value.
- What are the risks? As with your original mortgage, if you fail to make payments on your refinanced loan, the lender can foreclose on your home. Be sure you really need that cash payment, and you have a good use for it before you consider a refinance that could increase your monthly mortgage payments.
- What kind of loans qualify for cash-out refinancing? You can refinance any existing loan, including FHA, VA and conventional, and whether you have a fixed-rate mortgage or an adjustable-rate mortgage.
Any type of mortgage is a big financial decision. When considering a cash-out refinance, factor in the details of the new loan along with the goals you have for this type of refinance.
What Do I Need?
Has it been a while since you applied for your last mortgage? That's ok! We're here to help you prepare for your loan refinance application process.
You'll need much of the same information you needed for the original loan, but make sure everything reflects your current financial situation.
Bring critical documents, including:
- Tax returns and W-2′s and/or 1099′s
- Pay stubs
- Photo ID
- Current mortgage paperwork
- Survey
- Proof of any improvements made
- Title insurance
- 2 months of bank statements
When meeting with your mortgage broker, ask plenty of questions. It's essential to understand everything about the cash-out refinance process before you finalize the new loan.
Use A Cash-Out Refinance Wisely
When choosing a cash-out refinance, use it wisely. It's an excellent option for improving your credit score, upgrading your home, or paying down high-interest or medical debt.
When Is The Best Time For A Cash Out Refinance?
The best time for a cash out refinance is when your equity is up. With Seattle real estate prices around double what they were just 8 years ago, this could be a good time for you.
It also helps when mortgage interest rates are low. At the beginning of 2021 30 year mortgage rates were at historic lows of just under 3%.
When the financial benefits will pay for your refinance sooner than you plan to sell the home it is a good choice. For example, if the costs of refinance will be paid for in less than 24 months and you plan to keep the home for at least 5 years, then it makes sense.
It also pays to refinance when you are in a good borrowing position. When your equity is up, you’ve been in the same line of work for at least two years, and you have at least two months of payments in the bank. Don’t wait until you are on the brink of falling behind on payments.
Alternatives To A Cash Out Refinance
1. Debt Consolidation Refinance
If you don’t need cash in hand, then you can simply refinance and use your equity to pay off other higher rates debts and lower your overall monthly payments. This type of refinance may give you an even better interest rate.
2. Rate & Term Refinance
This type of refinance simply gives you a new interest rate, and if desired loan term. You can reduce the total amount of interest you’ll pay, your monthly payments, and even how soon you’ll pay off your home. As well as switching between an adjustable rate or fixed rate loan if you want to.
If you're not sure that a cash-out refinance mortgage is right for you, let us help! Contact us to see how we can help you find the right mortgage or refinancing solution for your Seattle area home.