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.
Have you heard of a cash-out mortgage? If you're looking for a way to lower your monthly mortgage payments, a cash-out mortgage is not the answer.
However, 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 homes 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.
In most cases, a home refinance should also reduce the overall amount you pay for your home when you make your final mortgage payment.
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. We'll talk more about why people choose to refinance with a cash-out loan, and if it's right for you.
Cash-Out 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.
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 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.
You don't repay the cash-out amount from your cash-out refinance. Instead, your monthly payment goes toward the principal and interest of the full loan amount.
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
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 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.
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. Plus, if you choose a cash-out refinance, you'll see lower interest rates compared to a HELOC.
- Tax Deductions—Your newly refinanced loan probably comes 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.
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 roll into your monthly mortgage payments, but be sure the closing costs are worth any savings you hope to gain from the refinance. Closing costs are typically recouped within 36 months of refinancing.
- 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 will include private mortgage insurance. Be prepared to tack on an additional 0.05% to 1.2% to the annual cost of your loan.
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.
Use the funds to add value to your home 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've paid at least 20% toward your original mortgage. Most lenders won't refinance anything with less than 20% equity, unless you are using FHA.
- How much can I borrow? Lenders usually allow cash-out refinances for 70 to 80 percent of the home’s value. FHA allows for up to 85 percent. Your home's most recent tax appraisal helps determine the value of your home and the amount to refinance but typically reflects a much lower value. The refinanced amount will pay off the original remaining loan amount plus give you the remaining amount in cash.
- 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? In general, your best option is a conventional mortgage, even if your original mortgage was an FHA loan. If you're a veteran or active-duty military, you might qualify for a VA Home Loan. When you find the right type of loan, you'll choose between a fixed-rate mortgage or an adjustable-rate mortgage for your cash-out refinance.
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
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.
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.