On the surface, applying for a cash-out refinance mortgage sounds like a no-brainer. You may be able to lower your interest rate, plus you walk away with some cash. But, there are some things you should consider before you tap into your equity with this type of refinance.
Here are some basic questions you should answer before determining if a cash-out refinance is the right move for you.
1. How long do you plan on staying in the home?
As with all refinances, it only pays to move forward if you have ample time to recoup the closing costs and fees that you’ll incur. This can take a few years. For example, if your monthly savings from refinancing is $100 per month and your closing costs are $4,000, then it’ll take a little over three years for those savings to pay off the costs. If you’re planning on selling your home before those three years, then you’re actually losing money.
Also worth noting is that you’ll have less equity in the home, since you’re taking out cash against the home’s value. This can make it harder to sell in the short term. But, if you plan to stay in your residence for the long term, then you’ll regain more equity over time.
2. What do you plan to do with the funds from the cash-out refinance?
It may seem like free money to take your dream vacation or splurge on your wedding. But there is no such thing as free when it comes to money that you’re borrowing against your home. In other words, that amount is rolled into your new mortgage principal. You’ll be paying interest on it for the next 30 years — or, however long your new loan term is. Is that new sports car worth it?
It’s a better idea to use the money toward something meaningful like paying for needed health care costs for a family member, or a sound investment like a major home improvement that will add value to your home. Some even use it to consolidate high-interest debt like credit cards.
If you need cash, but don’t want to touch the earned equity in your home, then a personal loan may be a better choice. Typically, personal loans have lower interest rates than credit cards and are quick and inexpensive to process — usually much quicker and less expensive than a cash-out refinance, which requires an appraisal and documentation similar to a home purchase loan.
There are no restrictions on how you can use the money both with a cash-out refinance or a personal loan — just make sure that it helps you reach your financial goals in some way.
3. How will your monthly payments be affected?
In general, it’s a good idea to refinance if it can save you money — either on your monthly mortgage payments or in interest payments over the life of the loan. But, unlike a streamline refinance, which requires a lower payment, with a cash-out refinance you may end up with payments that aren’t all that different. This is due to factors like your loan-to-value ratio, the interest rate you can qualify for, and how much cash you’re taking out. And, if you’ve refinanced in recent years, the drop in interest rate may not be dramatic enough to make much of a difference.
Get advice from a mortgage professional and see if a reduction in your monthly payment is possible — it could be the deciding factor for you.
4. Are you ready for a cash-out refinance now?
While you shouldn’t rush a major financial decision like a mortgage refinance, you should keep in mind that interest rates are at current all-time lows. According to Ellie Mae’s December Origination Report, the average 30-year loan interest rate increased to 4.07% in December from 4.04% in November. But even with this slight increase, rates have hovered at some of the lowest levels in years.
Even if you purchased your home in the last couple of years, you could still benefit from a refinance — there are 8.2 million homeowners who could benefit from a refinance in the market. No one knows when interest rates will head back up, so the longer you wait, the less beneficial a cash-out refinance may be for you.
5. Is a home equity loan a better idea?
If your goal is to get access to cash especially for home improvements, you may be better off getting a home equity loan or home equity line of credit. These are independent, second loans on top of your current mortgage, but with much lower closing costs than a refinance.
To decide, you should consider how many years you have left on your current mortgage. If you’re more than halfway through paying it off, it’s probably not a good idea to start over again, since most of your monthly payment is being applied toward the principal balance — a reduction in interest rate wouldn’t help you much. A home equity loan in this case may be a better option.
Apply for a cash-out refinance while rates are low
Cash-out refinance mortgages can be a great opportunity to lower your monthly payments, gain access to cash, and positively impact your overall financial well-being for homeowners in the right situation. If you want to know how a cash-out refinance could benefit you, then reach out and speak to a mortgage professional.