How to Take Advantage of a Cash-Out Refinance

Blog posted On October 29, 2020

Many home buyers have been taking advantage of record low interest rates the past several months by refinancing their mortgages. Refinancing your mortgage while interest rates are low is a great opportunity to lower your mortgage rate, change your loan terms, switch your loan type, or even withdraw equity to fund other expenses with a cash-out refinance.

To qualify for a cash-out refinance, you must first have enough equity in your home. Most financial experts recommend building at least 20% equity in your home before taking cash out.  Once you have enough equity, you can use a cash-out refinance to pay off your existing home loan and replace it with a new, larger mortgage. Then, you would receive the difference between the two loans in cash. For example, if your home is valued at $400,000 and your current mortgage balance is $300,000, you have $100,000 in home equity. With a cash-out refinance, you can make a new home loan higher than your previous balance of $300,000, but normally it will not be able to exceed 80% of your home’s value. Therefore, your new loan would be a maximum of $320,000, giving you $20,000 in cash.

Cash-out refinances can give you a lump sum of money, but most financial experts recommend that you avoid spending it on shopping sprees or other low-return expenditures. Instead, use this money to finance high-return investments such as consolidating debt, renovating your home, or even financing a second mortgage on an investment property.

Consolidate High-Interest Debt

Using a cash-out refinance can be an effective way to pay off debt such as credit card balances, car loans, or student loans. These loans generally have a much higher annual percentage rate (APR) than mortgages and you would want to pay them off as quickly as possible. With the recent record-low mortgage rates, using a cash-out refinance would be a very practical way to consolidate your debt rather than taking out a higher-interest personal loan.

Renovate an Existing Home

If you’re looking to build a real home office, expand your house in general, or update or repair some of your home features, a cash-out refinance is a useful tool. By using your home’s equity to repair or improve your home, you could improve the home’s value, which would help you gain equity in the long run and sell it at a higher price in the future.

Renovating your home could also earn you a tax deduction. Depending on your situation, you may be able to lower your taxable income by deducting a certain amount of interest you pay on your mortgage. This deduction is normally only possible with mortgage loans.  Talk to a tax professional about your local area’s specific tax codes.    

Finance a Second Home

If you’ve been trying to figure out how to fund your dream vacation house, consider a cash-out refinance. When purchasing a second home, your down payment will likely be higher than the down payment for your primary residence. By doing a cash-out refinance while interest rates are low, you could save thousands of dollars on your primary residence loan and help fund the down payment for your second home. Plus, you could save thousands of dollars on your second home as well if you opt for a fixed-rate mortgage while rates are low.

There are several advantages to a cash-out refinance if you put the money to good use. Using a cash-out refinance for low-return expenditures like vacations can be risky for your financial health. Keep in mind that, as with your initial mortgage, with a cash-out refinance you will have to pay closing costs. Furthermore, you will be extending the time it will take to pay off your mortgage.

Before applying for a cash-out refinance, make sure that you have a good enough credit score and sufficient home equity. We would be happy to help you review your home equity, asses your credit score qualifications, and help you through the cash-out refinance process!

Sources: Apartment Therapy, Experian, Time