What is a Cash-Out Refinance (and does it make sense for you)?

Life can get expensive, and sometimes we need access to large sums of money to fund it for a number of reasons, like starting a business, paying an unexpected medical bill, or finally paying off your high interest credit card debt, to name a few. And, if you’re a homeowner, you have the means to tap into your home’s equity to access the cash you need to fund your financial goals. 

One of the ways you can leverage your home’s equity and liquidate it into cash is through a cash out refinance. But what exactly is a cash out refinance, how does it work, and is it 

 the right move for you? There are a few points to consider – read on as we explain.

What is a Cash Out Refinance?

As Investopedia explains, a cash out refinance (or cash out refi, for short), is a “mortgage-refinancing option in which an old mortgage is replaced by a new one with a larger amount than owed on the previously existing loan, helping borrowers use their home mortgage to get some cash.”  

By refinancing your existing mortgage, you can potentially lower your monthly mortgage payments, land a lower interest rate, and access a sum of cash from your existing home’s equity – typically up to 80% of your home’s value.

How Does a Cash Out Refinance Work?

When you take a cash out refinance, you take out a new mortgage – one that’s more than what you currently owe on your existing mortgage, but less than your home’s current value. As such, you’ll receive the difference between the new mortgage and the mortgage balance you’re closing out in the form of a cash payment.

You can use that cash for pretty much anything – from funding a home improvement project, to paying off debt or starting a business. 

Does a Cash Out Refinance Make Sense for Me?

There are some situations where refinancing your mortgage and accessing your home’s equity through a cash payment make sense. If your credit score is in a better place than when you originally applied for your mortgage, a cash out refi could help you land a lower interest rate on your mortgage, and even help lower your monthly payments. 

What’s more, if you use the cash from your cash out refi to pay off existing debt, you could be furthering your financial situation for the better, and shaving years off high interest charges and additional monthly payments. 

It can also make sense to leverage a cash-out refi if you’re able to take advantage of the tax deductions associated with it. As Bankrate explains, if you plan to use the cash from your refinance to make home improvements and the project meets IRS eligibility requirements, you can potentially take advantage of the interest deduction at tax time. IRS eligible projects include adding a new bedroom or bathroom to your home, enhancing your roof, replacing windows, and even installing a home security system. 

While taking out a cash out refinance makes sense for some homeowners due to the reasons outlined above, it’s not always the best option. If you aren’t securing a lower interest rate, and you can’t afford to pay the closing costs associated with a cash-out refinance – about 3% – 5% of the loan to cover lender fees and the required home appraisal to secure your newly-refinanced loan – you may be better off taking out a personal loan or finding other means to fund your financial goals,

As with any financial decision, it’s best to consult with a trusted financial advisor to help you determine the best solution for your financial situation before making a decision. 

LEGAL DISCLAIMER

The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, we advise you to consult with a licensed advisor.