What is Cash-Out Refinancing and Is it My Best Option?

What You Should Know About Cash-Out Refinancing

If you’d like to collect the equity you’ve built on your home, you’ll want to look into cash-out refinancing. You’ll receive a lump sum, and that money can be spent on virtually anything. It could be a way for you to consolidate debt, cover the cost of future home renovations, or get the funds you need for an emergency expense.

With that said, if you’re in need of funds, there may be better options available to you than a cash-out refinance. The closing costs can be much higher than they would for other types of borrowing, and on top of that, it could put you at risk for home foreclosure. Because of this, it’s best to consider various options and make sure that cash-out refinancing is the best option for someone in your position.

It’s wise to look at both the benefits and the drawbacks of refinancing before making your decision. You should look at how you’ll benefit, but you should also be aware of the risks that you’re taking on.

What Is Cash-Out Refinancing?

what is cash-out refinancing

This type of refinancing allows you to replace your current mortgage with a new one that’s higher than the amount you currently owe on your home. You’ll be able to receive the difference between the amount that you owe and your home’s current value. Once you receive your cash, you can decide how you’d like to use it.

Generally speaking, you’ll be limited to borrowing around 80% of the home equity you’ve acquired. As an example, if you have a property with a value of $300,000, and you currently owe $200,000, you may be able to borrow up to $80,000.

You’ll receive the money from a lender as a lump sum. Depending on the terms of the loan, it may have an adjustable or fixed interest rate. The money you receive will be the funds that are left over after your previous mortgage has been paid off and you’ve covered closing costs in full.

To be approved for cash-out refinancing, you’ll typically need to meet these qualifications:

Credit Score: The minimum score required for approval can vary. Most lenders will be looking for a minimum score that’s somewhere between 600 and 640. With that said, there are lenders that would approve a customer with a lower credit score.

Debt-to-Income Ratio: Your debt-to-income ratio must be below 50%. In order to calculate your ratio, you should add up the debts you pay each month by your monthly earnings.

Home Equity: In the majority of cases, you’ll need a minimum of 20% equity.

Length of Home Ownership: Lenders will usually want you to have owned your home for a certain period of time. Requirements can vary from one lender to the next.

What Can Cash-Out Refinancing Be Used Toward?

It’s possible to use the money you receive from refinancing in many different ways, including:

Getting a Better Interest Rate: If your original interest rate is on the higher side, refinancing could help you to save. You may be able to exchange your previous loan for a new loan with more favorable interest rates.

Renovations: It’s also common for people to put the money they receive from refinancing into home upgrades. Kitchen and bathroom renovations are a popular option, as are patios and decks. If you use the money from your cash-out towards home renovations, you’ll be able to deduct the mortgage interest on your taxes.

Emergencies: Refinancing can be a way to get the funds you need for unplanned expenses, like auto repairs or medical bills.

Education: Money from refinancing can be put towards college tuition.

Debt Consolidation: Refinancing makes it possible to consolidate debt and pay off high-interest credit cards in full.

Will Your Credit Be Impacted By Refinancing?

While it’s likely that your credit score will change if you refinance, the difference won’t be significant in most cases. Some changes you may see include:

Hard Inquiries: When you apply for refinancing, the lender may look at your credit report. Inquiries can lead to a small, short-term credit score decrease.

Shopping Around: While shopping around can help you find the best interest rates, it could also lead to more inquiries. You can avoid this by applying with a few different lenders in a short period of time. In most cases, this will be treated as a single inquiry instead of multiple inquiries. If you wait months between applications, the impact on your credit score will be more significant.

Your Average Credit Age Will Decrease: If your old mortgage will replace, it will decrease your average credit age, which could lead to a small credit score decrease as well. With that said, if you made your previous mortgage payments on time, it’s likely that you’ll see a significant change in your credit.

Is Cash-Out Refinancing Right for Me?

It can be helpful to refinance in some situations.

As an example, it can be a fantastic way to get a better interest rate on your mortgage. A lower interest rate should be a priority when exploring your options for refinancing. In the long run, getting a better interest rate could lead to savings for you.

It can also be smart to look into refinancing if you plan on remodeling your home. By refinancing, you can get a substantial loan with reasonable interest rates. For some types of projects, you may even be able to deduct the mortgage interest from your taxes.

It can also be an option if you need additional funds to cover your child’s college tuition. Student loans have very high-interest rates, making refinancing a more reasonable option. Although there are clear advantages to refinancing, there are also negative factors to consider. Your home will be the collateral for your loan. If you’re unable to make your mortgage payments, your house could be foreclosed upon.

The closing costs can be significant, and it’s important to take them into account when you’re making decisions about how to proceed. It’s not unusual for loan origination fees and other closing costs to add up to approximately 2 to 5% of the total amount you’re borrowing. It’s especially important to keep these costs in mind if you’re refinancing to save yourself money.

There could be other fees associated with the loan as well, such as a fee for early repayment. The total cost could be as much as six months of interest payments. If you put the money towards debt consolidation, but then use your credit cards again afterward, you could put yourself in a worse financial position. Not only will you have to pay your new mortgage payments that are potentially higher, but you’ll also have high-interest credit card repayments to worry about.

What Other Options Should You Consider?

Cash-out refinancing is one way to get money to put towards high-interest debt. However, there are other options worth considering as well, such as:

Personal Loans: You usually don’t need any sort of collateral for a personal loan. This makes them an effective way to consolidate debts. Interest rates are typically less than what credit card companies charge.

Home Equity Loan: This is a fixed-rate loan that allows you to borrow against the equity you’ve built in your home. These loans usually have better interest rates than both credit cards and personal loans. With that said, this debt could also put your home at risk if you’re unable to make your payments on time.

Home Equity Line of Credit: Known as a HELOC, this type of loan is a different way to take advantage of your home equity. While cash-out refinancing gives you a lump sum of cash, you’ll receive a line of credit from a HELOC. You can borrow against that credit line as needed. It’s similar to a credit card.

Debt Reduction Strategies: There are techniques that have helped many people successfully pay off their debt. One method, known as the debt snowball method, have you prioritize paying off your cards with the lowest balances. After that, you move onto cards with higher balances. Eventually, your debt will be paid off in full. With the debt avalanche strategy, you’ll pay off your debt with the highest interest rate first. From there, you’ll move on to debt with a lower interest rate.

Negotiate with Creditors: If you can’t make your credit card payments, you may want to reach out to your card issuers. This could be a way for you to decrease your monthly payments, pause payments, or even bring your interest rates down.

Look Into Credit Counseling: If your credit card debt feelings overwhelming, you may want to connect with a credit counselor. You can work with a specialist to find the best option for you. Whether you’re able to better manage your debt, consolidate the debt, or settle, working with a debt counseling service can help you to work towards eliminating your debt.

In Conclusion

Cash-out refinancing is a way to utilize one of your most highly-valued assets: your home. If you use your home equity to borrow money, you can get additional funds that you can put towards other expenses, such as a home renovation or college tuition. In some cases, it could even make you eligible for tax deductions. With that said, trading equity for funds isn’t always going to be your best option. It could put your home at risk, and it could lead to substantial closing costs.

That’s why you won’t want to make any decisions about cash-out refinancing in a rush. Instead, you should look at both the benefits and the drawbacks before you decide how to proceed. Compare some of your different options and decide if refinancing is the best option for you.