What is a cash out refinance and when to use it?
If you have a significant amount of equity built up in your home and would like to convert that equity into actual money you can use, a cash out refinance may make sense for you. Here are some of the key things you should know.
What is a cash out refinance?
A cash out refinance is when you take out a new home loan for more money than what you owe on your current loan and receive the difference in cash. For example, if your home is worth $300,000 and you owe $200,000, you have $100,000 in equity. With cash out refinancing, you could receive a portion of this equity in cash. If you wanted to take out $40,000 in cash, this amount would be added to the principal of your new home loan. In this example, the principal on your new mortgage after the cash out refinance would be $240,000.
When is a cash out refinance a good option?
- When you have the opportunity to use the equity in your home to consolidate other debt and reduce your total interest payments each month
- When you are unable to get other financing for a large purchase or investment
- When the cost of other financing is more expensive than the rate you can get on a cash-out refinancing
What can I use the cash for?
You are free to use the cash in just about any way you want. Many people use it to pay down high-interest credit card debt. Even though you’ll still owe the same amount of total debt when all is said and done, you can save a lot in monthly interest payments. In this situation, your lender will most likely pay your previous lenders directly at the time of your closing.
Alternatively, some people use the cash for a major purchase or expense if financing is not available or is more expensive than the rate on a mortgage. In this situation, your lender may give you your cash directly to use at your discretion.
- Home improvement projects
- Education expenses
- Purchasing an investment property
- Paying for emergency expenses
- Vacations
- Elderly care
Be cautious about using cash-out refinancing or other long-term financing to pay for current or short term expenses. For example, if you use a cash out refinance to pay for a car that you’ll keep for six years, the interest rate will often be much lower than the rate on a new car loan, but you could be paying back the loan for another 24 years. If you use a cash out refinance to pay back credit card debt, you’ll have more credit available on the card, but remember that you still owe the same total amount, or a little more if you finance your closing costs.
Use our Cash Out Refinance Calculator to see how much equity you can take out of your home and estimate how much you’ll reduce your payments by consolidating your existing debt.
What are alternatives to a cash-out refinance?
If a cash-out refinance doesn’t work for your home’s equity, there are other options to borrow. Use our loan amount calculator to estimate how much you can be eligible for.
Home equity loan
Another option to access the equity you’ve built in your home is through a home equity loan. While a cash-out refinance replaces your current mortgage with new terms, a home equity loan can be an additional fixed rate loan. Usually, a traditional cash-out refinance has closing costs that can amount to hundreds or even thousands of dollars. However, you may be able to avoid these costs with a home equity loan.
HELOC
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Similar to a home equity loan, a home equity line of credit, or HELOC, more closely resembles revolving debt like a credit card. Unlike a home equity loan that provides you with a lump sum when you are approved, a HELOC extends a line of credit from which you can withdraw funds as you need. Any interest in the HELOC is based on the amount you withdraw, which can make it an attractive option for flexible withdrawals. Unlike a home equity loan, HELOCs typically use variable rates, which can fluctuate based on national economic factors. This can make your monthly payments change from month to month, which can make it more challenging to build a budget.
Personal loans
Personal loans use your credit rating to earn an unsecured loan. Given the security of home equity loans, most unsecured personal loans will have higher interest rates and lower borrowing limits.