The value of your home has probably escalated recently. That means you could have enough equity for a cash-out refinance. That’s great news if, for instance, you’ve dreamed of building that $30,000 master bedroom suite.
With the cash-out refinance option, borrowers can receive cold hard cash derived from the value of their home – up to 80 percent for the loan-to-value ratio (85 percent with an FHA loan), says JD Crowe, president of the Association of Mortgage Bankers of Georgia. He also helps people get loans every day as president of Southeast Mortgage of Georgia in Lawrenceville.
Who Qualifies for a Cash-Out Loan?
You are refinancing your current mortgage and getting an entirely new loan – hopefully with a smaller interest rate – and then receiving cash back in your pocket, he says.
“What we typically see with cash-out situations is someone that has a larger equity position,” Crowe says. “You don’t usually see people who just want to take out $10,000 in cash go through all this trouble.”
Crowe paints a scenario of the maximum amount someone might take out in a cash-out refinancing — A house is worth $200,000, and the person still has $100,000 to pay off on the mortgage. The new cash-out refinancing loan can go up to $160,000 with $100,000 going toward paying the original mortgage off and $60,000 going to the homeowners to do with what they want.
But he warns anyone thinking of refinancing in this way.
“It can be very risky. If there is a better place to get cash, you should exhaust those places first. But every situation is different,” he says. “Anytime someone is tapping into the equity in their home to change their lifestyle, they should have a conversation first with a lending professional that they trust. Then, they should get a second opinion from a financial planner or CPA and a lender.”
You have to really weigh your options and the reasons why you want to refinance.
“If your only reason is to take out $5,000, that’s probably not a good idea especially if you are adding more years to your mortgage or having to pay closing costs on the loan,” he says.
The cash-out refinance option has been around for a long time, he says, even during the mortgage crisis in 2008.
“But there was no home equity in many areas because the values of homes went down considerably,” he says. “Now, there is equity to tap into to cash out.”
According to the latest quarterly report by the National Association of Realtors in February, home prices in metro areas throughout the United States continued to grow—up 25 percent over the past three years on average. Single-family home prices in the fourth quarter of 2014 were $208,700, up 6 percent from the year before.
Common Reasons Homeowners Use a Cash-Out Refinance
When someone decides on a cash-out refinancing, they need or want the money for a variety of reasons.
“One of the typical reasons is making an investment of some sort such as buying another property or getting a second residence. A cash-out refinance is usually the cheapest way to get money for another home,” he says.
Other reasons can be to pay off higher interest rate debt such as credit cards or car loans, college tuition, home improvements, medical bills, vacations or anything else they see the cash helping their lives out.
Crowe gives an example of someone who is nearing retirement age that a cash-out refinancing might work. They have refinanced recently to a 15-year loan. But they need to improve their cash flow. So, they refinance to a 30-year term loan and get some cash out for other bills.
“In a perfect world, people are supposed to have their homes paid off before retirement. But that’s not the reality anymore,” he says.
Somebody else might use the cash-out refinancing because they have found an amazing investment opportunity that could make them big profits in the future. They look to their home’s equity to get the money they need to fund that investment.
But Crowe emphasizes that there are fees associated with refinancing, and it takes time and effort to go through the process. You need to think about the fact that once you take cash out of your home’s equity, you lose all that equity you’ve built up. You also are taking on more debt that you need to pay off to rebuild the equity once again. So, do you really want to take out $10,000 to go on an exotic trip to Bali, and then pay for it the next 15 years of your loan?
One of the advantages of cash-out refinancing is that some fees and interest might be tax deductible. Talk with your CPA to see how that can help you with your tax bills.
Apply for a Cash-Out Refinance
Low mortgage rates and rising home equity is spurring more homeowners to take some of that equity as cash. For those who are equity-rich and in need of cash, this is a very viable option.
Click here to verify your eligibility for a cash-out refinance.