What Is It?
You might be wondering, what is cash-out refinancing and how does it differ from traditional mortgage refinancing? Well, here goes.
A cash-out refinance is when you secure a new mortgage loan or refinance for more than what you currently owe; you keep the difference between the old and new loans. You can then use the additional cash to pay off high interest debt such as credit cards, tuition loans or major medical expenses, finance the purchase of other properties or other investments, or to make home renovations/upgrades. A mortgage refinance, on the other hand is when you get a new loan to replace your current mortgage – typically to take advantage of a lower interest rate.
We should also point out that cash-out refinancing is distinctly different from a home equity line of credit (HELOC). A cash-out refinance loan is a new mortgage loan that replaces your original mortgage, while a HELOC is a separate loan that becomes a second mortgage in addition to your current original mortgage.
Let’s look at the benefit and drawbacks of cash-out refinancing so you know what you’re dealing with.
The Benefits Of Cash-Out Refinancing
- Easier to qualify – typically easier than with other types of loans as you already own the home, have established a payment history, and you owe less than what the home is worth.
- More tax deductions – using the cash generated to pay off other debt that is not tax deductible could result in additional tax savings, since mortgage interest is tax deductible.*
- Improve credit score – when you use the cash-out refinance to pay off high-interest credit card debt, it not only eliminates the higher-interest monthly payment, but it has a positive impact on your credit score.
- Consolidate debt – with credit card debt paid down or paid in full, your credit utilization goes down considerably, which also can positively affect your credit score
- Lower interest rate and more stable – HELOC or lines of credit typically come with an adjustable rate, while cash-out refinancing does not.
The Potential Drawbacks Of Cash-Out Refinancing
- Closing costs – when evaluating the cash benefit of a cash-out refinance, don’t forget to take closing costs into account.
- Higher rates – while you may get a lower interest rate than your current mortgage, your cash-out refinance rate may be higher than a non-cash-out refinance at market rate.
- Longer term – typically you reset your current mortgage for a longer term over which you must make payments.
- New PMI – borrowing more than 80% of your home’s value could require you to pay private mortgage insurance (PMI), potentially adding hundreds of dollars to your monthly payment
As you can see there are potential pros and cons to cash-out refinancing. What might make the difference is your individual situation. Here are a few scenarios that might help you decide whether this loan option is right for you:
- If interest rates are lower than your current mortgage, a cash-out refinance could put money in your pocket and lower your monthly payments
- If you’ve been making payments for a while and a significant portion of your monthly payment now goes to paying off principal instead of interest, run the numbers; refinancing into a lower rate may not offset extending your loan term
- If you don’t plan to use the funds all at once, but rather over a number of years, you might want to consider a HELOC as you can withdraw funds only when you need them, and pay interest only on the amount withdrawn to date; with a cash-out-refinance, you’ll start paying interest on the entire amount immediately
The Bottom Line
A cash-out refinance can be a smart financial decision and excellent way to fund home renovations, consolidate debt, or pay for a college education. Contact a PrimeLending loan officer to discuss whether a cash-out refinance loan makes sense for you.
*PrimeLending is not authorized to give tax advice. Please consult your tax adviser for tax advice for your specific situation.