Pros And Cons Of A Cash-Out Refinance

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Cash-out refinance pros and cons

Pros of a cash-out refinance

You can access a sizable amount of money

The biggest upside of a cash-out refinance is that you can get a considerable amount of money by unlocking home equity you already have — often much more than you could get with a credit card or personal loan. In fact, if you have a major expense, a cash-out refi might be one of the few ways you’re able to pay for it.

You may be able to lower your interest rate

If mortgage rates are lower now than they were when you first got your mortgage, your new cash-out mortgage could come with a lower interest rate, depending on your credit score and other factors. Even if rates are higher now, you’ll likely still get a lower rate doing a cash-out refi compared to getting a credit card or personal loan.

Your payments won’t change

If you had a fixed-rate mortgage and refinance to a new fixed-rate mortgage, even with cash out, your monthly mortgage payments won’t change. That’s not the case with credit cards and home equity lines of credit (HELOCs), which generally carry variable rates. These predictable payments can make it easier to manage your budget over the long term and eliminate the stress of a fluctuating rate and payment.

In addition, each time you make an on-time payment on your cash-out refi loan, you’re doing your credit report a favor: On-time payments demonstrate strong personal finance habits that can help boost your credit score over time.

You could benefit from tax deductions

If you itemize your tax deductions, you could take advantage of the mortgage interest deduction with the new loan — and potentially even more so if you use the cashed-out funds to buy, build or improve a home.

Cons of a cash-out refinance

You owe more money

Because you’re taking out a larger loan amount — the remaining balance on the original mortgage plus cash out — your overall debt load will increase. A larger loan might also increase your monthly payments, depending on what rate you get and whether you refinance to a shorter or longer loan term.

You’re putting your home up as collateral

As with your original mortgage, your home is the collateral for a cash-out refinance, so if you don’t repay the loan, you could lose your home.

You have to pay closing costs

Just as you paid closing costs on your original mortgage, you’ll pay similar expenses when you refinance. The good news: Refinance fees aren’t nearly as expensive as the closing costs on a home purchase. However, they’re usually costlier than the fees associated with a HELOC or home equity loan.

You could be tempted to borrow more for the wrong reasons

If you’re cashing out to pay off a mountain of high-interest credit card debt, take a long pause. Make sure you’ve addressed whatever spending issues led you to run up the debt in the first place. Otherwise, you might find yourself in a spiral and ultimately end up worse off than before.

Should I get a cash-out refinance?

If you’re considering a cash-out refinance, ask yourself these key questions to help decide if it’s right for you:

• Can you get a lower interest rate? A cash-out refinance could be ideal if you qualify for a better interest rate than you currently have and plan to use the funds to improve your finances or your property. If you can’t get a lower interest rate, however, a cash-out refinance might not be the best move, especially if you refinance to a new 30-year loan.

• What are you planning to do with the money from the cash-out? Investing in upgrades to your property with the money increases its value and makes it more enjoyable for you, making this a good reason to do a cash-out refi. You might also plan to use the funds to help pay off other high-interest debt.

• How long are you planning to stay in the home? With any refinance, you need to make sure you will be able to hit the break-even point that justifies the upfront investment of closing costs. If you expect to sell your home in the short term, it might not make sense to do a cash-out refinance; you’ll have to repay the larger balance at closing.

Alternatives to a cash-out refinance

Aside from a cash-out refinance, other options that allow you to borrow against your home’s equity include:

• HELOC: A home equity line of credit (HELOC) is a revolving credit line that functions much like a credit card. With a HELOC, you can borrow what you need, repay the amount borrowed and then borrow again. HELOCs come with a specific draw period during which you can continue to borrow funds as needed. Once the draw period closes, you pay back the remaining balance in installments.
• Home equity loan: Home equity loans provide a lump sum payment similar to a cash-out refinance. You pay back the funds in installments, usually at a fixed interest rate that’s lower than many other types of consumer lending options.

Both options are often quicker and less expensive to get than a cash-out refi. However, they also use your home as collateral and could come with higher interest rates compared to refinancing.

FAQ

• How long does it take to close a cash-out refinance?
  

  Closing on a cash-out refinance typically takes 30 to 60 days. Ask your lender for its average closing time to get a sense of what to expect. Keep in mind you won’t get the cashed-out funds for at least three business days after closing. This is required by law.

• What are the requirements for cash-out refinancing?
  

  The requirements for a cash-out refinance vary by lender, but most lenders will want to see a minimum credit score of 620 and a debt-to-income (DTI) ratio of no more than 43 percent. Some lenders set higher standards, however. Discover, for example, requires a minimum credit score of 680. In addition, lenders require you to have had your original mortgage for at least six months.

• Does cash-out refinancing hurt your credit?
  

  A refinance can affect your credit score for up to one year, but the impact is usually minimal.