By: Yara Zakharia, Esq.
Americans who have built equity in their homes can put it to good use through the mechanism of a cash-out refinancing. Basically, with every mortgage payment that is made, a greater investment in the home's equity takes place. Some of that equity can be traded for cash by way of a cash-out refinancing.
Cash-out refinancing involves refinancing your mortgage for more than what you currently owe and then pocketing the difference. The threshold for a cash-out mortgage refinance is a new mortgage with a loan amount that is at least 5 percent higher than the original mortgage balance.
To illustrate the concept of cash-out refinancing, let us say you owe $50,000 on a $100,000 house and need $20,000 to add a guest room. You could refinance your mortgage for $70,000, and the bank will then write you a check for the difference of $20,000. Cash-out refinancing replaces your first mortgage with a new mortgage.
Typically, the interest rate on a cash-out refinance is lower than the interest rate on a home equity loan. If the mortgage refinance has an interest rate that is higher than your current rate, then mortgage refinancing is not a good idea. In such a case, a home equity line of credit (HELOC) would be a more sensible choice.
Homeowners are usually allowed a mortgage refinance up to 100% of their property's value. However, if a homeowner borrows more than 80% of the home's value, he or she may have to pay a higher interest rate or private mortgage insurance. In such a scenario, a HELOC would probably prove to be a more favorable option.
There are closing costs associated with mortgage refinancing, and they can amount to hundreds or thousands of dollars. Homeowners are advised to first verify whether interest rates have dropped sufficiently so that they can recover the costs in a year or two with the savings generated by the lower interest rates.
Cash-out refinancing provides access to substantial funds, which are distributed in a lump sum and can be utilized for any purpose. Homeowners frequently choose a cash-out refinance to pay for such major expenditures such as:
- Business expansion and business ventures
- Payment of high-interest credit card debt
- Home improvements and repairs (ex: a new kitchen or bath)
- A vacation
- A real estate investment (i.e., a vacation home)
- College tuition
- Purchase of high-cost items, such as a new vehicle, a boat, or car
A cash-out refinancing can also provide homeowners with an alternative source of income, enabling them to have cash on hand for emergencies or unforeseen opportunities.
In sum, cash-out refinancing offers Americans the choice of tapping into their home equity and exchanging it for a potentially large amount of cash. Cash-out refinancing offers numerous benefits, and when used properly, is a good way to make money work for the homeowner.
