Homeowners

Need Some Extra Money? Here’s When a Cash-Out Refinance Might Make Sense

Emergency expenses, major life events, debt consolidation, home improvements—real life can get expensive. But what can you do if you’re short on cash and don’t want to cover these big costs on a high-interest credit card?

A cash-out refinance, where you refinance your existing mortgage for more than you currently owe (and pocket the extra cash), may help.

“When reviewing if a cash-out is the right move, we look at how much cash back homeowners want, how much equity they have available to borrow against, and what their current [mortgage] rate is,” said Amber Ernst, a sales manager at New American Funding, in Bettendorf, Iowa.

“When you show homeowners how much they can save in interest over time, that is the really magical piece,” she said.

Below, we’ll review how to determine if a cash-out refinance is right for you.

How a cash-out refinance loan can improve your finances

Cash-out refinances can make a big difference in your financial outlook in several ways:

Potentially lower interest rate

If you got a mortgage when rates were higher (or when you had a lower credit score), you might qualify for a lower rate now.

While you could simply get a lower rate with a traditional mortgage refinance, a cash-out refi is a two-birds-one-stone deal: Get a lower mortgage rate and get a low-interest loan to cover medical expenses, car repair, vet bills, home improvements, weddings, vacations, you name it.

That lower rate is often as competitive or more competitive than other loan products, such as home equity loans, home equity lines of credit (HELOCs), and personal loans.

And the rate will likely be lower than paying for your expenses with plastic.

Debt consolidation

If you’re drowning in high-interest debt from past credit card purchases or personal loans, a cash-out refi may be the answer.

“I have helped several people pay off tens of thousands in 25%-plus interest rates on credit cards” using cash-out refinances, said Ernst.

When is it better to do a HELOC instead of a cash-out refinance?

Like a cash-out refi, a home equity line of credit (HELOC) lets you borrow against the equity in your home. However, it’s a “second mortgage,” not a mortgage refinance.

For a set period, often five to 10 years, you can draw from an open line of credit to cover ongoing expenses. Then, you’ll have a repayment period, typically 10 to 20 years, to pay back what you borrowed.

Here’s why you might get a HELOC instead of a cash-out refinance:

• Good mortgage rate: You may not want to refinance your mortgage if you have a very low interest rate.
• Small amount: A HELOC makes sense if you only need to borrow a little bit of cash.
• Ongoing project: If you’re doing home renovations over the next few years and aren’t sure how much they will cost, having a line of credit you can draw from as needed can be a huge help.

When does a personal loan make more sense than a cash-out refinance?

Cash-out refinance rates are almost always lower than personal loan rates, which can go as high as 36%. Personal loan terms are also often capped at five or seven years for repayment.

So why would you ever get a personal loan if a cash-out refinance were available?

• Low mortgage rate: If your current mortgage rate is lower than what you could currently get through a cash-out refi, then a cash-out refinance may not make as much sense for you.
• Small amount: If you only need a few thousand dollars, refinancing your entire mortgage might be a little dramatic. Instead, you may prefer to get a personal loan for a small amount and pay it off within a few years.
• Closing costs vs. origination fees: A personal loan may have high origination fees, but they’re only a percentage of the cash you’re borrowing. Closing costs for a cash-out refinance can be higher, since you’re paying a percentage of the full mortgage amount plus the extra cash you’re borrowing. So, make sure to figure out the costs for each loan before choosing one.

What to consider before taking out a cash-out refinance

Borrowers should be aware that there are fees and various costs to taking out a cash-out refinance, just like with other types of loans.

Closing costs

A cash-out refi has closing costs, just like a traditional mortgage. These can range from 2% to 6% of the total amount being refinanced.

If you’re refinancing $100,000, that could mean $2,000 to $6,000 in closing costs. However, you can typically roll closing costs into the amount you’re financing.

Extended loan term

A cash-out refinance could extend the timeline for fully paying off your home. For example, if you’re 10 years into your 30-year mortgage but refinance to a new 30-year term, you’ve got another 30 years of mortgage debt, instead of 20.

Potentially higher loan payment

If you’re refinancing your home for a larger amount, your monthly mortgage payments may go up, even if the interest rate goes down. The specifics will vary depending on the amount you borrow, your existing mortgage rate, current mortgage rates, as well as other factors.

Private mortgage insurance

Conventional loans typically require private mortgage insurance (PMI) until you’ve paid off 20% of the loan. Federal Housing Administration (FHA) cash-out refinances may also require a mortgage insurance premium, similar to PMI.

These are all important considerations for homeowners when deciding which loan is right for them. Some might prefer taking out smaller sums through a HELOC, while others may want the ability to consolidate their debt through a cash-out refinance.

“[Cash-out refinances] alleviate so much stress and pressure for the customer,” said Ernst.

Amber Ernst, NMLS # 406037