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What is a Cash Out Refinance?
If you have good equity in your home and could use some of that money for other purposes, you may want to consider a cash out refinance of your mortgage. It is a great option for some homeowners to tap into their equity while potentially also refinancing at a lower interest rate.
Who Should Consider a Cash Out Refinance?
Cash out refinancing is ideal for a homeowner who is sitting on a healthy amount of equity in their current home and isn’t planning on selling any time soon. If you are in this position, perhaps there are other higher-interest debts you would like to pay down or home improvement projects you would like to finance. You could leverage that equity into a restructured home loan that turns your home equity into cash.
Use Your Home Equity to Pay Off Other Debts
Think about it. Many of us are dealing with car loans, high credit card balances and student loans. These loans typically have much higher interest rates than mortgages. It could make a lot of sense to cash out some of your equity in a refinance and then apply those funds toward paying off these other debts.
Home Improvement Investment
Another common strategy for a cash out refinance is to pay for home improvement projects that will help increase the value of your property and thus help your equity grow even more over time. This approach is basically reinvesting your equity into your home to do some much-needed remodeling or make major upgrades such as installing solar panels. Why pay these expenses out-of-pocket when you can finance them with a restructured mortgage?
Whatever you want to use the money for, you are essentially borrowing it from yourself with a cash out refinance. You’ve earned that equity as a homeowner. Now, you can leverage it for other uses.
How Does a Cash Out Refinance Work?
How a cash out refinance works is fairly simple. You refinance the principal amount you currently owe on the house plus however much extra you would like to “cash out” from your earned equity. The total amount for the new loan would be higher, but that extra amount would go straight into your hands to use however you see fit.
Depending on how the cash out refinance loan is structured and when you time the mortgage, you may be able to lower your interest rate. Your loan amount will definitely go up. This means you may be paying a little more each month for your mortgage payments. Or, in some situations, homeowners may end up paying roughly the same amount or even a little less. It all depends on how much cash you take out, how much you are able to lower your interest rate and a few other factors.
Example of a Cash Out Mortgage
Let’s draw up a simple example to illustrate how a cash-out mortgage work. You have a home that is worth $500,000. You still owe $300,000 on the mortgage. That means you have $200,000 of equity in the property. Meanwhile, you have been wanting to buy a new $40,000 car and you have $20,000 in credit card debt that you would like to pay off. You refinance your home loan at the principal amount of $360,000. $300,000 of that still goes toward what you own on the home. $60,000 is cashed out and can be applied toward the new car and the credit card debt.
You still own your home and you have paid off your other debts. Your mortgage payment may go up a little or it may not, especially if your original 30-year fixed loan was more than $360,000 and had a higher interest rate. Plus, you won’t have a car payment with high interest or being paying interest as you chip away at your credit card debt. It really is a great scenario if all the numbers line up.
Is a Cash Out Refinance Right for Me?
It is important to note that a cash out refinance is not for everyone. It is not “free money.” You are borrowing from yourself and you will be paying interest on that equity borrowed. If you don’t really need the money, then you shouldn’t take it out. You may just want to do a traditional mortgage refinance to lower your monthly payments and/or reduce your payoff period. If the money is for home improvements, investments or other purposes where you don’t need a huge cash amount upfront, you may also want to consider a home equity line of credit (HELOC) rather than a cash out refinance. It’s all about understanding your options and making the decisions that are right for your financial situation.
Closing Costs and Qualification Standards
There will be standard mortgage loan closing costs associated with a cash out refinance, so some of the money you take out may need to go toward those fees. Also, there will be qualification standards required by most lenders. Those with poor credit scores, high debt-to-income ratios or low home equity may not qualify or get terms as favorable as borrowers in better financial situations. Each refinance program has different rules and guidelines, so understand your options and make smart mortgage decisions.
If you are considering a cash out refinance with today’s great mortgage rates—or you are looking for a traditional mortgage refinance or HELOC—contact Moreira Team today for more information and to get started with your application.