Pros and Cons of a Cash-Out Refinance
Refinancing your mortgage is like souping up a sport bike. The right tools and the right plan can reduce your rate and retrofit your home loan to fit your needs. But poor planning and shortsighted spending often spark trouble down the road.
Before you start to tinker with your mortgage, research your options and choose the right tool. Looking to leverage your home equity to cover renovations or other major expenses? A cash-out refinance could be your best bet!
What is a cash-out refinance?
A cash-out refinance is a way to refinance your current mortgage for more than the amount owed. You take the difference in cash. While you may be able to use it to lower your rate and adjust the terms of your loan, the primary purpose of a cash-out refi is to convert home equity into liquid assets.
How does a cash-out refinance work?
For example, you need $30,000 to turn your kitschy kitchen into a tasteful country farmhouse. But you still owe $100,000 on a $300,000 home. Instead of a simple rate and term refinance, you can refinance your mortgage for $130,000 and pull out the extra $30,000 for project materials and labor.
Cash-out Refi Pros
Self-investment: From home improvements to financial investments, a cash-out refinance can give you the means to upgrade your home and set up a future nest egg. Wise planning can increase your home’s value and build equity down the line.
Debt consolidation: A cash-out refi can be used to pay off student loans, medical bills, credit cards debts and other necessary expenses. While a cash-out refi can help you pay down unsecured high-interest debt, this strategy essentially raises the stakes. Using your mortgage to consolidate debt means your home becomes the collateral. If anything happens and you can’t make your payments, the lender can foreclose on your home. Don’t bite off more than you can chew!
Tax benefits: If you use your cash-out refi for home improvements, the interest is tax deductible. If you use the cash another way, the interest is tax-deductible up to $50,000 for an individual or $100,000 for a couple.
Steady interest rates: With the right timing, you could capitalize on market conditions and knock down your monthly payment. In general, cash-out refinancing offers lower interest rates than personal loans. They also feature consistent payments—perfect for ongoing home renovations.
Cash-out Refi Cons
Higher rates than other refinances: Because you refinance for more than the amount owed, cash-out refis are innately more risky than traditional rate and term refi products. This means they come with a slightly higher interest rate than the baseline.
Additional costs: Anytime you refinance, you go through the closing process and all the costs and fees it entails. With a cash-out refi, you’ll also need to pay interest on the chunk of change you pull out of your mortgage.
Higher risk: Keep in mind—the more equity you take out of your home, the more risk you add if money gets tight or the property value decreases. It’s unwise to drain your equity for vacations or other superfluous purchases. Your home isn’t a piggy bank!