How Does a Cash Out Refinance Work?
Your home is a place of comfort and happiness – but it’s also an investment. In fact, homeownership is one of the primary ways Americans have built wealth for years. Building equity is a major benefit to buying, but what happens when you want to take advantage of the equity you’ve built in your home without selling it? A cash-out refinance is a great method for achieving this goal. Here’s how it works.
New Mortgage, Plus Cash Out
Like all types of refinancing, a refinance with cash out replaces your existing mortgage with a new one. In this case, however, your new mortgage will have a higher balance than your existing one based on your home’s appraised value. The benefit of this is that you receive the equity difference between your new and old mortgage (minus closing costs and other fees), providing you with funds to use as you wish. Many homeowners choose to use those funds for home improvements, paying off debt, or bolstering other investments.
One important point here is: if your home has appreciated in value since you purchased it, that will work in your favor. Since how much cash you receive is based on your home’s current appraised value, a higher value means an increase in the amount you can borrow.
A basic requirement for a cash-out refinance is having equity accrued in your home. Lenders require homeowners to retain 20 percent equity in their house, which is to say that you can cash out up to 80 percent of your home equity. When you choose a cash-out refinance, your home is appraised. Let’s say that appraised value is $350,000. If your current loan balance is $150,000, you could refinance that loan up to $280,000 (or 80% of your home’s value) and receive up to $130,000 at closing, minus any fees. Homeowners can use a home refinance calculator to determine how much they can borrow with a mortgage refinance.
Pros and Cons
You may be wondering, should I refinance my mortgage to take cash out? One major benefit of a cash-out refinance is that the interest rates are typically lower than those on home equity lines of credit or a home equity loan. So, if your goal is to renovate your home with as little interest as possible, this is an attractive loan choice. In addition, if interest rates have improved since you initially closed on your mortgage, the terms on your loan can improve as well.
One con of a cash-out refinance is – as with any home loan refinance – your house is the collateral. If you’re unable to repay your loan, you risk foreclosure, which is why it is ill-advised to use a cash-out refinance to pay off credit card debt. You may also pay more interest over the life your loan through refinancing.
A cash-out refinance can be a great tool to leverage the equity you’ve acquired in your home to make improvements, add to more lucrative investments, or receive cash to use any other way you wish.