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There are many reasons why you might consider a cash out refinance of your mortgage loan. In today’s article, we will discuss the basics of this mortgage product, some of the key pros and cons you should know, and a few situations where cash out refinancing makes sense for today’s homeowners.
What is a Cash Out Refinance?
A cash out refinance is exactly what it sounds like. It is the process of refinancing your home loan—ideally at a lower interest rate and/or shorter repayment period. Cash out refinancing essentially allows you to “cash out” some of your home equity to use for other expenses.
Let’s say you qualify for a significantly lower mortgage rate than your current home loan. You may be in a position where it makes great sense to “restart” your 30-year mortgage with a refinance at the much lower rate, thus reducing your monthly payments. Or, perhaps you opt to keep a similar monthly payment amount. However, the lower interest rate enables you to qualify for a 10 or 15-year fixed rate mortgage rather than the 20+ years you may still have left on your original 30-year home loan. You’ll pay what you are already paying, but have your house paid off much sooner.
A cash out refinance is an alternative solution. For example, your property value has gone up by $100,000 since you first bought the home. Cash out refinancing can give you the option to tap into some of the equity and get cash back once the refinance loan has been approved by your lender.
Why You May Need a Cash Out Refinance
We should first state that you should only consider a cash out refinance if you can benefit from the money other than just padding your bank account. Cashing out will add principal to your original outstanding loan amount. It is basically a second loan on top of refinancing your existing principal amount. A cash out finance may allow you to keep the same monthly mortgage payments while benefiting from that cash you took out, or you may even be paying more or less depending on the interest rate, new loan length and how much you cashed out.
So, why would you want to pursue a cash out finance of your mortgage loan? It makes sense when you are able to put the money to good use. Here are some examples:
Emergency Expenses—Unexpected medical bills, emergency home repairs or something else where the cash will help you out of a tough situation.
Reducing/Eliminating Other Debts—Odds are your mortgage will be the lowest interest debt you have. Leverage your equity with cash out refinancing to pay off high-interest credit cards, student loans, car loans or other outstanding debts.
Home Improvement—A very common use for a cash out refinance is to put the money back into your property by making strategic home improvements. It could be a home addition, energy-efficient upgrades, major renovations/remodeling or different projects that will ultimately increase the resale value of your home. Investing the cash back into your property is a great strategy because it can help boost your equity even more as time goes on.
Education Expenses—Some parents will consider a cash out refinance to pay for their children’s college tuition and education expenses.
Business Investment—Business owners or investors may use home equity to finance capital growth or cover important expenses/debts, rather than a standard business loan that may offer higher interest rates.
Is a Cash Out Mortgage Refinance Right for You?
It’s important to note that cash out refinances are not for everyone. If you don’t need the money for something else, do not take it out. Let your equity keep growing and refinance your home loan at a lower rate to reduce the total interest amount, reduce monthly mortgage payments and/or shorten the term of your loan.
Whether or not a cash out refinance is a good solution will depend on a variety of factors. You’ll want to talk with a trustworthy mortgage lender to review your specific situation. Understand how much your property is currently worth, how much equity you have accrued, what kind of new interest rate you qualify for, and if it’s worth cashing out to pay for other expenses.
We are just scratching the surface. There are many more specific topics, questions and scenarios to cover as we help you determine if a cash out refinance is a good idea for you.