What is a cash-out refinance?
A cash-out refinance essentially is what the name suggests. Get cash as a part of a refinance of an existing mortgage.
Immediate next question: Is that possible? How do I get the cash? How much cash can I get?
For starters, yes, you certainly can. If you didn’t know that, there’s nothing to feel bad about. A lot of people don’t.
As far as the questions about why, how and how much go, that’s what we are about to discuss in great detail.
Why do a cash-out refinance?
People do a cash-out refinance when they want to borrow cash for a need they have. More specifically though, people use it when they need to borrow large sums of money at a reasonable cost.
Since the closing costs, the time taken and the work involved with a cash-out refinance is significant, it doesn’t make sense when the amount is small or the need is urgent.
A few examples of situations where a cash-out refinance makes sense are:
If you have several credit lines open with high balances on them and at high rates of interest, it makes sense to pay them off using cash from a cash-out refinance.
Reducing the number of credit lines can not only help lower your total monthly debt payment, it can help improve your credit score.
Home renovation and improvement
Home renovations can often be quite expensive. Using equity in one’s home as a source of cash to renovate a home is a good way to finance it at a very reasonable rate.
One can think of it as making an investment in the home itself. By doing so, not only do you get to enjoy the newly-modeled home, the value of the property is also likely to go up which ultimately benefits you when you sell the property.
One note of caution though: not all improvements and home renovation lead to an appreciation in home value. Some improvements can, in fact, cause a reduction in value. So it’s worth consulting renovation professionals to review if your planned renovation will yield an increase in value.
One popular use of a cash-out refinance is when there is a new investment opportunity. For example, buying another property or investing in one’s business.
If the Return-On-Investment (or, ROI) on the investment is higher than the rate of cash-out refinance (after taking into account the closing costs), then it might not be a bad idea to borrow at a low rate and invest it at a higher rate to make extra income.
College education for kids
One common use of cash-out refinance is to borrow money to finance the education for kids. The main reason is that the interest rate on education loans can be quite high.
If you have sufficient equity in the home and interest rate for the refinance is significantly lower than that of an education loan, it might make a lot of financial sense.