What Is a Cash-Out Refinance and When Should You Do It?

When it comes to crazy terms that only insiders understand, the finance world is probably topping the charts with weird language. Cash-out refinance is one of these terms that newcomers will find hard to understand. Knowing what exactly cash-out refinance is, though, can be super important when you want to get a loan refinanced under specific circumstances. So, make sure that you know what cash-out refinance is all about and check out this article that will explain everything about it.

– What is Cash-out refinance?

You probably know what the concept of refinancing refers to already. To put it simply, refinancing a loan, such as a mortgage, means that you take out a new loan to take care of an old loan. Why would you do such a thing? Well, different loans come with different conditions attached to them. For example, if you had a loan with a 15 percent interest rate over the next five years, but you found an opportunity to take out a new loan over the money that you currently owe, but only at 10 percent interest, then it can make sense to refinance. What you do then is you take out the new loan, use it to repay the old loan and then just focus on repaying the new loan at a lower interest rate. A different reason for refinancing can be that you are able to make lower payments every month, change the total duration of the loan, change which borrowers are part of the loan obligation, or get your hands on cash through home equity.

This last point is basically what cash-out refinance is: It is a specific type of refinancing a mortgage that allows you to take advantage of an increase in your home’s equity. What you do under cash-out refinance is that you replace your previous mortgage with a new, larger one, which can quickly get you access to large amounts of cash. Keep in mind, though, that a cash-out refinance usually means that your interest rate will go up. This is where a cash-out refinancing option differs from a rate-and-term refinance, where your mortgage amount and interest rate do not change.

When it comes to determining how much cash you will actually be able to take out from your cash-out refinance, the deciding factor is the loan-to-value ratio of your property. If the ratio is in your favor, it will mean that you can get more cash out of the refinancing. Otherwise, the maximum cash limit set by your lender will be lower, sometimes to the point where going for a cash-out refinance will not be worth it anymore.

Since there are alternatives to a cash-out refinance, however, when should you go for it? Most importantly, when should you go for a rate-and-term type of refinancing option instead?

– What to choose: Rate-and-Term or Cash-Out Refinancing?

If you just want to have a regular, run-of-the-mill mortgage loan refinance, then rate-and-term is probably the right way to go. This is because refinancing your mortgage this way can give you access to a lower interest rate or simply to better loan terms in general. The best time to refinance like this is, of course, when interest rates today are much lower than they used to be when you originally took out your mortgage. Another great reason to go for a rate-and-term refinancing option may be that you are economically better situated than you were when you first took out your mortgage. This could mean that you can now afford to repay your mortgage in 15 years rather than 30, which will directly translate into massive savings when it comes to interest rates.

Cash-out refinancing, on the other hand, is the option to go for if you simply need more cash-in-hand right now. Since your equity in your home slowly increases over time, as you pay off your original mortgage, you are sitting on an ever-increasing pile of money that can be tempting to tap into – especially since it is tax-free, as it does not count as income as far as the government is concerned. How it works is that a cash-out refinance pays you the difference between your original mortgage and the new mortgage that is based on higher equity in tax-free cash. Before you get the whole amount of cash that you are due after cash-out refinancing, however, you need to wait until closing, around 45 to 60 days further down the line.

Just keep in mind that cash-out refinancing can be expensive. Higher interest rates, point costs, and other fees mean that it can be a risky option to take. Also, if your credit score is not very good, lenders may not even want to offer you the option to go for cash-out refinance in the first place.

So, in other words, cash-out refinance can be a great way to get your hands on a lot of money, but you should be aware of the costs involved before you decide on going for it.