Did you know that typically over time your home builds value? That value is referred to as your home’s equity and it is the difference between the current value of your home and the amount outstanding on your mortgage. You may be able to take advantage of this equity to pay for major expenses with a cash-out refinance.
A cash-out refinance is a method for you to tap into your home equity. You’ll refinance your existing mortgage into a new one for a larger amount and pocket the difference, minus closing costs. But, remember that you’ll be using your home as collateral so be sure that your new payments are affordable. These loans can come with a slightly higher interest rate because the lender is taking on more risk with the higher loan amount.
Typically, cash-out refinance loan amounts are limited to 80% of your home’s value, but some mortgage programs can go higher. If you’ve built up a large amount of equity in your home and want to use it to meet some of your financial goals, a cash-out refinance can be a good option.
Let’s take a look at the three most popular reasons borrowers decide to use a cash-out refinance.
Paying for College
Paying for college is no small feat. Refinancing your mortgage to help fund your child’s tuition is a popular option for its one-time cash return, but there may be some unexpected drawbacks too.
Pros:
- The flexibility of a cash-out refinance’s lump sum lets you choose where you want to spend your money. That could mean books, room and board, tuition, and any other college-related expense in between.
Cons:
- When filing your FAFSA (Free Application for Federal Student Aid), the lump sum you receive from your refinance will be calculated into your Expected Family Contribution. So, that extra money in the bank could mean a smaller financial aid package.
- When you refinance, you’re taking on a new loan with new terms. This could extend the length of your mortgage, and possibly increase the total cost of your loan as well.
Financing a Home Addition or Renovation
Refinancing is often used to help fund home improvement projects. This trend is especially true when mortgage interest rates are so low, as other traditional forms of credit tend to carry higher interest rates.
Pros:
- If your refinancing allows you to cash out with enough money, you may be able to fund all or part of your renovation without putting a strain on your regular budget.
- Making a renovation with a high average return on investment may help increase the value of your home. So, if you pick the right renovation, you may be able to use equity to build up more equity. Talk about a win-win situation!
Cons:
- While you may be able to benefit from a lower interest rate, closing costs on a refinance tend to be higher than other traditional home improvement loans. It takes some number crunching, but pays to fully consider all your options.
Consolidating High-Interest Credit Card Debt
For some, being able to pay down credit card debt is a dream come true. A cash-out refinance could be a solution. Still, there are considerations you need to make before moving ahead.
Pros:
- With the average variable interest rate for credit cards at 16.05%, consolidating credit card debt with money from a cash-out refinance could mean serious relief from high-interest payments.
- The psychological benefits of lowering your credit card debt with cash from a refinance can’t really be quantified. But for some, the satisfaction is enough to justify the decision.
Cons:
- Consolidating credit card debt with a cash-out refinance does not eliminate debt (it moves it from a higher to a lower interest rate), and it may be only a temporary fix if you don’t also change your spending habits. (If you have trouble with this, try one of these personal financing apps!)
With pros and cons for each option, making the right choice ultimately depends on your specific situation. But for many homeowners, a cash-out refinance offers a solid solution for funding these major expenses.