A cash-out refinance is a great option for paying down debts, getting finances in order, or for home improvements and other major expenses. A refinance uses the equity, or built up value, in your home to finance these desired items.
For example: you owe $150,000 on your mortgage, but your home is valued at $250,000. You have approximately $100,000 in available equity to assist with financing upcoming projects or consolidating existing debts.
It’s important, however, to use a cash-out refinance option frugally and be conscious of your finances, budget and your home’s value. It’s recommended when considering a cash-out refinance that you are using the extra cash for sensible reasons.
Cash-Out Refinance vs. Home Equity Loan
Both a cash-out refinance and home equity loan can assist with taking advantage of the equity in your home, but have their differences.
Cash-Out Refinance: The replacement of your existing mortgage loan with a larger loan. A cash-out refinance will increase your mortgage balance and will only require one monthly mortgage payment.
A refinance could potentially extend the term of repayment and you will likely have associated closing costs. Closing costs can typically be financed into the loan, so you would not need to pay out-of-pocket.
When refinancing your existing mortgage with a cash out, you are typically restricted to a loan amount at 80% of your home’s value, or less.
Home Equity Loan: An additional mortgage that takes a second position behind your existing mortgage. A home equity loan will require an additional monthly mortgage payment and is commonly spread over a shorter term – 5 to 15 years.
In most instances, a home equity loan will allow you to utilize a larger portion of the built up equity in your home, where a cash-out refinance allows up to a maximum of 80%.
Should you consider a Cash-Out Refinance or Equity Loan?
When considering a cash-out refinance or equity loan, I recommend asking yourself the following questions:
- Consider the potential change in interest rate and/or repayment term. Will these changes still benefit you long term? Extending the term on your mortgage can lower your monthly payment, but can also add years of additional interest.
- It is likely you will incur costs with a refinance. Although these costs can be financed with the loan, how long do you intent to stay in your home? Using a refinance calculator can assist you in determining how long it will take to reach your “break-even-point” (when the monthly savings from the refinance are enough to cover the estimated closing costs).
- What is the purpose of the extra cash? Are you consolidating high interest credit cards? Using the funds for education or wedding expenses? Home improvements? Ultimately, it will be your mortgage and it’s up to you to determine what is valuable when considering a refinance.