In this article
- Cash-Out Refinancing: The Pros and Cons
- How Does It Work?
- What are the Advantages of Cash-Out Refinancing?
- The Potential to Lower Your Interest Rate
- An Extended Loan Term Might Translate Into Lower Payments
- Money to Pursue Your Life Goals
- Pay Off Higher-Interest Debt
- Potential Tax Deductions
- What are the Drawbacks of a Cash-Out Refinance?
- Your Interest Rate on Your Loan May Increase
- Extending the Term of Your Loan Will Mean Additional Interest Over Time
- The Potential for Larger Monthly Payments
- Closing Costs
- Foreclosure Risks
Cash-Out Refinancing: The Pros and Cons
What You Will Learn:
- How a cash-out refinance can provide the funds to help you reach your goals.
- The potential pros of cash-out refinancing.
- The potential cons of cash-out refinancing.
Houses are more than just places to live, they are also financial assets that can assist you in funding one or more goals through different life stages. With cash-out refinancing, you can use this asset through the equity in your home (the portion of the property that you own). The equity in your home is worked out by calculating the home’s value and subtracting what you are still owing on the mortgage.
How Does It Work?
With a cash-out refinance your mortgage will be changed to reflect your new loan balance, which is obviously going to be higher than your current mortgage. The additional amount, which is worked out on a percentage of the home equity will be given to you in a cash payout after you have closed on the loan.
Cash-out refinancing is often a versatile tool to provide access to funds, which could potentially change your current financial situation for the better or in the years to come. However, refinancing is one of those serious decisions. This is why you should look at the benefits and drawbacks to make sure this is the correct option for you.
What are the Advantages of Cash-Out Refinancing?
While the exact advantages will have to do with your specific situation, below are a few of the primary benefits linked to cash-out refinancing:
The Potential to Lower Your Interest Rate
The interest rates on mortgages are how much borrowers pay their lenders to provide them with a loan. The mortgage rate that you received typically depends on several external factors, including market and economic conditions, and your financial situation which will include your credit rating.
Do a bit of research to find out whether the rates of mortgages have gone down since you secured your loan. Look closely at your current finances. A lower interest rate might help you to save significantly every month and for the duration of the loan.
An Extended Loan Term Might Translate Into Lower Payments
You may be under the impression that your monthly payments are going to increase automatically since your loan balance is going to be larger. But it is not always how it works out.
In most cases, when the repayment term on the loan is extended, the monthly costs will be lower. For example, if you have already paid 5 years off your 30-year mortgage, and you are refinancing to another 30-year term, the loan is reset and you will have another 5 years to pay back the loan.
On the positive side, this may help you to bring down your monthly expenses, and provide you with a cash payout all at the same time.
Money to Pursue Your Life Goals
After you have closed on a cash-out refinance, you will be receiving a large chunk of cash into your account. Depending on the equity in the home, this could range from a couple of thousand dollars to ten thousand or more.
You can then use this cash in any way that you want to go after your goals. For example, you could use the money to fund a vacation home or investment property, start a new business, or provide funds for your child’s college tuition.
Many people often use these payouts to reinvest value into their homes by conducting upgrades. Renovations will not only improve the usability and look of spaces in your home, but they can also help to increase your equity once again.
Pay Off Higher-Interest Debt
The interest rates on home loans are usually lower when you compare them to other debt and loan types, such as personal loans, student loans, or credit cards. Using the funds from a cash-out refinance to get rid of these bills could save you a lot of money in regards to interest charges.
Potential Tax Deductions
In certain cases, cash-out refinancing can result in tax savings. For instance, you may be afforded the opportunity to write off the interest from the balance you have cashed out when you have used these funds for upgrades that increase the value of your home.
These are upgrades that are called “capital improvements”. Examples of these include:
- A swimming pool
- A new roof
- New storm windows
- Heating or central air system install
- New bathroom or bedroom addition
The IRS has more details provided on these deductions. But when you have questions about the way cash-out refinance could affect your taxes, it is best to talk to a tax expert or professional.
What are the Drawbacks of a Cash-Out Refinance?
Here are some of the common potential disadvantages of cash-out refinance:
Your Interest Rate on Your Loan May Increase
When swapping out your current mortgage for an updated loan, the interest rate may be higher, which will depend on the latest market environment. This could mean that your cash-out refinance might increase the borrowing costs and you will be left with a bigger loan amount.
Extending the Term of Your Loan Will Mean Additional Interest Over Time
Even though extending your repayment term might allow for a bit more wiggle space in your current monthly budget, you might be liable for more interest when it comes to the lifespan of the loan.
The Potential for Larger Monthly Payments
When it comes to a cash-out refinance, you will be borrowing a higher amount than what you previously owed on your original mortgage, so that you can receive a cash payout after closing. This could mean (depending on the interest rate and the loan term), that you may be left with a bigger monthly payment when compared to before.
If this is the case, you will need to make sure that your current budget will allow for these increased costs.
Similar to the original mortgage that you secured, you will be liable for closing costs when it comes to refinancing. Closing costs could translate into thousands, which you could either pay upfront or roll into the new loan.
Mortgages, whether for refinance or purchase are known as secured loans, which means the property will be the collateral. This means if you start falling behind on your payments after your cash-out refinance, you could risk losing your home to foreclosure.