The Downsides of Cash-Out Refinancing

Cash-out refinancing can be a great option for homeowners who have a lot of home equity and need cash for specific purposes. Tapping into your equity could help you make significant home improvements—which, in turn, can allow you to grow your equity even more in the future. However, you may want to think twice about a cash-out refinance loan (or at least how much you borrow) if you are spending the money in some other fashion. 

Cash-out refinancing may still be a worthwhile solution if you need to pay off other high-interest debts, educational expenses and large medical bills. It may provide a safer borrowing scenario compared to personal loans and letting your debts build up too much. A cash-out refinance loan essentially allows you to borrow from yourself, using your home equity as collateral. You should never take out more than you actually need. There are a few downsides you should understand before you make your decision. Here are some of the considerations to keep in mind:

cash-out refinancing

Increasing Your Mortgage Amount

Whatever cash you borrow from your equity will be added to your existing mortgage loan principal amount. A new mortgage loan will be issued with this total as the basis for your future monthly payments (along with interest and other standard fees). You will want to make sure you can afford the new higher payments.

Homeownership Plans

Another thing to think about is what your future looks like as a homeowner. Are you planning to sell this particular property within a couple years? Then, cash-out financing may not make sense unless you are investing the cash immediately back into your house. Perhaps you are making repairs, improvements and upgrades that will increase its potential resale value and net you a larger financial return when the sale is completed. Then, a cash-out refinance loan could be worth it right now. If you are just using your equity to pay off other debts or spend frivolously, then you could be hurting yourself in the near future when selling so soon.

Cash-out refinancing can also make sense if you are planning to stay in your home for a long time. Making home improvements can make your life better and you’ll have plenty of time to recoup the equity you cashed out as the property continues to appreciate over time. If you are using the money to pay off other expenses/debts, then you will want to weigh the pros and cons and understand the financial impact of increasing your mortgage loan amount. It may still be worth it in the long run if you are eliminating large financial burdens.

Closing Costs

There will be closing costs as part of the cash-out refinance loan closing process. These will include a credit check, home appraisal and other standard fees and taxes. Closing costs on a cash-out refinance loan will be similar to a standard home refinance, which is usually around 2-4% of the total loan amount. Just keep in mind the loan total will be higher when cashing out equity along with refinancing your existing loan principal. You can expect to pay these closing costs when the new loan is financed. Some mortgage lenders may allow you to roll some or all of the fees into the new loan, but that is only adding more to your principal total.

Home Equity

You will need a healthy amount of home equity to qualify for cash-out refinancing. Most lenders will require you to maintain at least 20% of your home equity after the new loan, meaning the total amount you can borrow is generally 80% of your home’s appraised value. You will need enough equity to borrow any cash and then you still cannot take all of it out. The only exception here is VA loan cash-out refinancing, which does allow for up to 100% financing.

Alternative Solutions

Depending on your home equity, your overall financial situation and how you intend to use any equity you cash out, there could be different lending options available to you. It’s important to do your research. Talk with your accountant. Consult with multiple mortgage lenders. Figure out what your best solution(s) could be. Cash-out refinancing generally offers the best mortgage rates compared to home equity loans, personal loans and home equity lines of credit (HELOCs), but each lending option has its pros and cons that you need to understand.

If you have mortgage questions—including cash-out refinancing and other ways to tap into your home equity—we have answers. Contact Moreira Team | MortgageRight today and let us know how we can help you with all your home loan needs.