What Is Cash-Out Mortgage Refinancing?
A cash-out refinance replaces an existing mortgage with a new loan with a higher balance, sometimes with more favorable terms than the current loan. The difference between these two loans is provided to the homeowner as cash.
A cash-out refinance differs from a traditional mortgage refinancing, which simply replaces your current loan with a new loan that has a new set of terms and in many cases, a lower interest rate.
A cash-out refinance also differs from a home equity line of credit (HELOC), which allows you to borrow cash using the home-equity as collateral. HELOCs function as a second mortgage, with the borrower withdrawing and repaying funds on a more flexible schedule, and the government allowing a tax deduction for interest payments. Unlike traditional first or second mortgages, a HELOC interest rate is not fixed; the rate varies from month to month with the prime rate.
Cash-Out Mortgage Refinancing Advantages
- Use your home equity to pay for improvements that will increase the property value of your home.
- Take advantage of the potential tax-deduction benefit associated with the interest paid on a mortgage loan.
- Pay off high-interest and/or high-balance credit cards or eliminate other high interest debts to save money.
- Pay for unforeseen expenses, such as emergency medical bills or costly car repairs.
- Helping to pay for college tuition.
Cash-Out Mortgage Refinancing Disadvantages
- Interest Costs: You’ll restart the clock on all of your housing debt, so you’ll increase your lifetime interest costs (borrowing more also does that).
- Foreclosure risk: Because your home is the collateral for any kind of mortgage, you risk losing it if you can’t make the payments.
- Closing costs: You’ll pay closing costs for a cash-out refinance, as you would with any refinance. Closing costs are typically 2% to 5% of the mortgage - that’s $4,000 to $10,000 for a $200,000 loan. Make sure your potential savings are worth the cost.
- Enabling bad habits: Using a cash-out refinance to pay off your credit cards can backfire if you run up your credit card balances again.
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