When you’re looking to make improvements to your home or pay down debt, a cash-out refinance is an option you may consider. With a cash-out refinance, you’re essentially taking out a new mortgage for an amount greater than your current mortgage. The difference between these two mortgages is given to you as cash.
For example, let’s say you have a home valued at $250,000, and you owe $150,000 on your existing mortgage. If you take out a new mortgage loan for $200,000, you could receive $50,000 in return. You’re using part of the equity that you’ve built up on your home and turning it into cash.
Types of Cash-Out Refinance
The most common type of cash-out refinance is where you can use the funds for any purpose. The example above depicts this type of cash-out refinance option.
The second type is known as a limited cash-out refinance. This type only allows you to use the generated funds for a specific purpose. This option is usually chosen when seeking to lower the mortgage’s interest rate or to change other terms of the mortgage. For example, if you wish to switch from an adjustable interest rate mortgage to a fixed-rate mortgage, you can receive up to $2,000 in cash, which must be used for closing costs.
Requirements for a Cash-Out Refinance
Lenders may have different requirements for approving a cash-out refinance. Typically, these requirements relate to your credit score, which must exceed a certain threshold (usually higher than for other loan types). Also, you must have owned the home in question for at least a year. And the loan-to-value (LTV) - the mortgage amount divided by the appraised property value – often must be 85% or less.
Pros of Cash-Out Refinance
The interest rate on a cash-out refinance is generally lower than on other options, such as a home equity line of credit. This is especially helpful if you purchased your home when interest rates were high, as you could save a considerable amount of money when refinancing.
Credit cards and other high-interest debts can be consolidated by using a cash-out refinance; this saves you money on interest. You’ll want to factor in closing costs and additional fees before choosing this option. Overall, paying off your other debt with a cash-out refinance can improve your credit score.
There are also potential tax incentives with a cash-out refinance.* Credit card interest isn’t tax-deductible, but your mortgage interest payments are. So choosing a cash-out refinance could reduce your taxable income.
Factors When Considering a Cash-Out Refinance
Since a cash-out refinance will have different terms from your existing mortgage, you should always verify the fees and interest rate. And as with any other type of refinance loan, you will have to pay for closing costs. These costs typically range from 3% to 6% of the mortgage amount - which may end up as more expensive than staying with the original mortgage. You will need to calculate your mortgage amount and the loan terms to determine whether refinancing is viable for you.
Using your house as collateral will always have some risk. If you’re suddenly unable to make payments on your loan, you risk a foreclosure on your house, and potentially bankruptcy. If the amount you borrow exceeds 80% of your home’s value, then you’ll likely need to pay for private mortgage insurance (PMI).
The bottom line is that a cash-out refinance may be a good choice if, after all, fees and other considerations, it results in you saving money and accessing cash for a useful purpose. Consolidating your existing debt, or making necessary home improvements, are good reasons for a cash-out refinance. Simply desiring capital for an unnecessary purchase is not.
NASB can provide more information and answer all your questions about cash-out refinance. Contact one of our loan specialists at 888-661-1982, or click here to learn more.
*This is not intended to and does not constitute legal advice or financial / investment / tax advice. North American Savings Bank does not make any guarantee or other promise as to the results obtained. The consumer should consult a tax adviser for further information regarding the deductibility of interest and charges.
