When is a Cash-out Refinance Loan a Good Idea?

cash-out loan

If you are a homeowner, chances are you’ve potentially heard about refinancing your mortgage. Refinancing your mortgage is basically when you replace your current mortgage with a new one – however, if you have enough equity built up in your home, you could potentially do a cash-out refinance loan.

What is a Cash-Out Refinance Loan?

A cash-out refinance loan is very different from a normal refinancing mortgage loan. While you’ll still take out a new mortgage on your home, instead of taking out the amount of money you have left on your mortgage, you’ll take out more than you owe. You’ll then subtract the cost of your leftover mortgage, and that difference will then be turned into cash that goes into your pocket.

Let’s go over an example to get a better understanding of what a cash-out refinance loan is and how it works.

Let’s say that you owe $70,000 on a house that’s worth $240,000. You’ve been doing some research, and you’ve discovered that you can get a lower mortgage rate if you refinance your loan, plus you would like to free up some cash so that you can make home improvements.

In this situation, you would have the option to refinance your home for more than the $70,000 that you owe on your mortgage. Say you wanted to take out $50,000 cash so that you could do those home repairs. You could then refinance your mortgage for $120,000; $70,000 would be for your mortgage loan balance and then $50,000 would be cash that you would receive to use on home improvements.

cash-out refinance loan

No matter how much you decide you want to refinance your home mortgage loan for, you’ll still have to prove that you can afford the monthly payments and qualify for the loan. You usually need to have 20% equity in your property to be eligible for a cash-out refinance loan. Plus, you’ll need to provide the usual documentation of income, assets, and debts to even be able to get your refinance loan.

Why Would I do a Cash-Out Refinance Loan?

The most common reason that people would go for a cash-out refinance loan is that the money that they receive can be used for home improvements. By being able to pay for home improvements, a homeowner can build up equity in the house and add to their home’s value.

Alternatively, some people will do a cash-out refinance loan to pay for college tuition.

When is it a Good Idea to do a Cash-Out Refinance Loan?

While a cash-out refinance loan might sound like a great opportunity, it’s not for everyone. In some cases, refinancing your mortgage can help you save money by allowing you to get a lower interest rate on your loan. However, you can quickly get those lower loans by doing a home equity line of credit – which also allows you to unlock the equity in your home.

A cash-out refinancing loan makes the most sense if you want to get a lower interest rate on your existing mortgage balance while also being able to take out some extra money from the equity that you’ve built up in your home.

Another great idea for using a cash-out refinancing loan is if you have high-interest debt that you’re needing or wanting to pay off. For instance, if you have credit card debt that you want to pay off, it would make sense to use a cash-out refinancing loan to do this.

However, you should note that you’re paying off debt with a loan that is using your home as collateral. So, keep in mind that the consequences of not paying your mortgage are a lot more drastic than not paying a credit card balance because you could lose your home for not making mortgage payments.

When Should You Avoid Cash-Out Refinancing?

While you might be able to save money by refinancing your mortgage, you can lose money on the closing costs of doing the refinance. This is because closing costs can account for 3 – 6% of your loan amount – which can mean paying up to several thousand dollars depending on the amount of your loan.

You should try to avoid doing a cash-out refinance loan if you don’t necessarily need the money for a specific reason – in this case, you’d be better off just leaving your home equity alone. By doing this, you’ll be debt-free once your home is ultimately paid for.

cash-out loan options

Finally, it would be best if you always reminded yourself that your home would be the collateral for these loans. Therefore, it would be best if you were incredibly confident that you’ll be able to afford to make the new payments every month or you could risk losing your home.

Final Thoughts

A cash-out refinance loans can be incredibly beneficial to homeowners if they are looking for a way to tap into their home equity. That money can be used to make home improvements that would create even more value to their home or could be used for significant debts such as college tuition. Plus, it can help you get lower mortgage payments by acquiring a lower interest rate.

However, they can be quite risky if they are done for the wrong purpose or at the wrong time. You should always make sure to talk to a home loan specialist before you decide to do cash-out refinance loan to make sure it’s best for you.

Remember: your home would be the collateral for the loan, so you need to make sure that you can afford the payments.

If you’re considering a cash-out refinance loan for your mortgage, you should check out this cash-out refinance calculator. This calculator will help you figure out if you would benefit from going forward with a cash-out loan or if you should consider a different option for tapping into your home equity. This is a significant first step to seeing if a cash-out refinance loan works for you!

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