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When To Use A Cash-Out Refinance – Show DFP 300×250
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A cash-out refinance lets you use your home equity to pay for anything you want—and therein lies its allure. Want to increase the square footage of your home? Keep your kid out of student-loan debt? Pay off your credit cards? Buy an RV? You can do any or all of these things with the cash from your home. Whether it’s a good idea to refinance your mortgage in this manner is another question—one that we’re here to help you answer.
What Is a Cash-Out Refinance?
A cash-out refinance replaces your existing mortgage with a new, larger mortgage. You withdraw the difference between the old mortgage and the new, and you can use the money however you want.
The most common ways homeowners use this cash, according to Freddie Mac’s most recent analysis, are to pay off bills or other debt (40%), for home repairs or new construction (31%), to increase their cash savings (14%), to buy a car (9%) or to pay for college (7%). Some borrowers used their cash for more than one purpose.
How Cash-Out Refinancing Works
Cash-out refinancing lets you access your home equity through a first mortgage instead of through a second mortgage, like a home equity loan or line of credit. You will need to have 10% to 20% equity left after the refinance. The percentage required depends on the lender and whether you’re willing to pay for private mortgage insurance (PMI) on the new loan.
PMI is an extra cost that borrowers typically pay when they don’t put at least 20% down to buy a house or when they don’t have at least 20% equity after a cash-out refinance. It protects the lender if you stop paying your mortgage. A cash-out refinance may not be cost effective if you’ll have to pay PMI as a result.
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Calculating How Much Money You Can Get from a Cash-Out Refi
How much money could you get from a cash-out refi? To calculate the amount, you need to know three things:
- How much your home is worth (home value)
- How much you owe on your mortgage (mortgage balance)
- How much equity your lender requires you to have left after refinancing (retained equity)
Lenders will use a physical appraisal or an automated valuation model—a software-based comparison of similar properties—to decide how much your home is worth. You’ll be allowed to borrow as much as 80% or 90% of that amount, depending on the lender’s rules. The 10% to 20% of your home’s value you can’t borrow is your retained equity.
From this new amount you can borrow, subtract what you owe on your current mortgage. The difference is the cash you’ll receive. While it might feel like a payday to you, it’s not taxable as income because it’s a loan. Also, you don’t have to cash out the full amount your lender allows you to; you can take less. Why pay interest and fees on money you don’t need to borrow?
Standard Refi Vs. Cash-Out Refi
A standard refinance, or rate-and-term refinance, changes your interest rate, the number of years you have to repay your mortgage or both. The most popular reason to do a standard refinance is to lower your interest rate.
Sometimes, homeowners who are getting a lower rate through a refinance will also move from a 30-year mortgage to a 15- or 20-year mortgage. This way, they don’t start all over on paying off their home, and they may even shave off years of payments. That means they’ll spend less money on interest in the long run. You can get a shorter term with either type of refi.
Other times, homeowners are motivated to refinance by financial constraints. A standard refi that restarts the 30-year payment clock can give you a lower monthly payment, especially if you’re getting a lower interest rate. A cash-out refi will usually increase your monthly payment because you owe more overall on the mortgage.
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First Published: Jul 23, 2020, 4:06am