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Should I take cash-out through refinancing?

A cash-out refinance is an alternative to a standard home equity loan that many people utilize for expensive transactions instead of using their cash savings. If you need to consolidate debt, repair, or renovate your home or pay for college expenses, you might want to consider cashing out on a portion of your home’s equity.

What is cash-out refinancing?

A cash-out refinance replaces your existing mortgage with a new loan that is equivalent to your home’s current appraised value, which should be more than what you presently owe on your house. You then take your new loan amount and its current appraised value, subtract what you owe from your previous mortgage and the difference goes to you in cash. This is what sets it apart from traditional refinancing, which replaces your existing mortgage with a new one for the same balance and a better interest rate. It’s possible that a cash-out refinance may get you a better interest rate, in addition to the cash, and it typically comes with a lower interest rate than a home equity line of credit or HELOC.

Once your cash-out refinance has been completed, you can spend this cash as you see fit, though it’s always best to use it for expenses that give you a return on your money. Paying off credit card debt can improve your credit score and eliminate high-interest rates, which makes it a good use for the money (as long as you don’t run up your credit card balances again).

Many homeowners use the cash for home improvements to increase the value of their home, which helps rebuild the equity you took out for the refinancing. Additionally, the home improvement expenses may qualify for a mortgage tax deduction.*

If you have a child that is considering student loans to pay for college, be sure to check their interest rates versus what you can obtain with a cash-out refinance. You may be able to help your student save substantial amounts of money and reduce their financial burdens after graduation. Or, if you’re still paying off your own student loans, a cash-out refinance may help you retire that debt for good. 

Private mortgage insurance for conventional loans. 

One thing to consider when calculating the benefits of a conventional cash-out refinance is private mortgage insurance (PMI), which you will have to pay if you borrow more than 80% of your home’s value. For example, if your home is valued at $200,000 and you refinance more than $160,000, PMI will probably be required. Private mortgage insurance typically costs from 0.55% to 2.25% of your loan amount each year. PMI of 1% on a $200,000 mortgage would cost $2,000 per year or about $167 added to your monthly mortgage payment.

Can you get a lower interest rate? 

Refinance interest rates are based on your credit score, loan amount, zip code, and other criteria. Because your credit score has a big impact on your rate, it’s important to review your credit report and correct any errors prior to refinancing. It’s not unusual to find a delinquent payment on your report for an account you’ve never had or one that you closed years ago. Get those corrected and make all your payments on time to raise your score.

If your credit score is still not where it needs to be, consider working on improving it for a while before refinancing your home.

How does a cash-out compare to a HELOC? 

A HELOC is comparable to a cash-out refinance because it gives you access to funds from a portion of your home’s equity. A HELOC is different in that it’s not a loan, but a line of credit. You’re still borrowing against the money you’ve already invested in your home, but instead of receiving a lump sum of money, you’re given access to that line of credit. It functions like a credit card in that you have a certain amount of money available to borrow and payback. You can take what you need when you need it, and you only pay interest on the amount you withdraw.

HELOCs often begin with a low variable interest rate, which means it can increase or decrease according to designated benchmarks. Of course, this means your monthly payment may increase or decrease as well. The HELOC monthly payment will be separate from your mortgage payment, rather than rolled into it, and the length of a HELOC is shorter than most mortgages. Instead of a 15- or 30-year term, you’re typically given five-to-ten years to pay it off. 

Determining whether a HELOC or cash-out refinance is right for you depends on your current financial situation, how much equity you have in your home, and your planned uses for the money.

Here’s a summary of the pros and cons of both programs.

Cash-out Refinance:

Pros

  • Interest rates tend to be lower than other options like HELOCs and home-equity loans.
  • You have the flexibility to use the cash for anything you want, like home repairs, paying off high-interest credit cards, school tuition, and more.
  • The interest from your initial mortgage may be tax-deductible, depending on how it’s structured and where you live.
  • There are multiple types of loans available with this process, with term, fixed, and variable rate options.

Cons

  • Typically, a cash-out refinance will extend the timeframe for paying off your mortgage.
  • Depending on the existing interest rate on your mortgage, you could end up with a higher interest loan and larger monthly payments.
  • You may have closing costs, which generally range from 3% to 6% of the total refinanced amount.
  • If you borrow more than 80% of your home’s value, you’ll have to pay for private mortgage insurance.

Home equity line of credit (HELOC)

Pros

  • You only pay interest on the amount of money you actually take from the line of credit.
  • You may get a tax break if your HELOC is used to improve your home.
  • You can borrow up to 85% of the value of your home, versus 80% with a cash-out refinance.
  • If you currently have a good interest rate, a HELOC will allow you to maintain that rate while still obtaining cash to use however you see fit.
  • There are closing costs, but they tend to be lower than those of a home equity loan or mortgage.

Cons

  • The interest rate is variable, so it could increase at any time, making your payments larger and more unpredictable.
  • It comes with a short term of five-to-ten years, requiring you to pay it off quicker.
  • You will be making two payments on your house versus one – your existing mortgage and your HELOC payment.

Click here to read more about your HELOCs and cash-out options. 

Making the right choice.

You’re probably starting to get an idea of which type of financing fits your situation. Either of these programs can make sense if you can get a good interest rate and have a sound use for the money.

Before deciding whether to apply for a HELOC or a cash-out refinance, consider how much money you need and how you plan to use it, interest rates, fees, monthly payments, and tax advantages. We don’t recommend that you use these to fund vacations or buy a new car, because you’ll have no return on your money. By contrast, if you use the money to fund home renovations or repairs you’re building equity in your hand, and if you use it to consolidate debt you’re improving your financial situation.

*This does not constitute tax advice. Caliber cannot discuss tax related items, please consult a tax professional regarding applicability to your specific tax situation.

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