What You Need to Know About Cash Out Refinance
Homeowners often find themselves in need of substantial funds for various reasons, from home improvements to debt consolidation. One popular option to access the equity built up in a home is through a cash out refinance. This financial tool can provide a lump sum of money, but like any financial decision, it comes with both advantages and potential drawbacks. In this post, we’ll explore the pros and cons of cash out refinance, helping you determine if it’s the right choice for your financial situation.
What is Cash Out Refinance?
A cash out refinance is a type of mortgage refinancing where a homeowner replaces their existing mortgage with a new, larger loan. The difference between the new loan amount and the original mortgage balance is paid out to the homeowner in cash. This allows homeowners to tap into their home’s equity without selling the property. Essentially, it’s a way to borrow against the increased value of your home or the principal you’ve paid down over time. Cash out refinances are often used for major expenses such as home renovations, debt consolidation, or funding education costs. As with any financial program, there are both pros and cons of cash out refinance which we’ll discuss later.
How Does Cash Out Refinance Work?
In a cash out refinance, the process begins with a homeowner applying for a new mortgage that exceeds the balance of their current mortgage. The lender then assesses the home’s current value and the homeowner’s equity. If approved, the new mortgage pays off the existing loan, and the homeowner receives the difference between the two loans in cash, minus closing costs. For example, if a home is worth $300,000 and the current mortgage balance is $200,000, the homeowner might take out a new loan for $250,000. After paying off the original $200,000 mortgage, they would receive approximately $50,000 in cash (less closing costs). The homeowner then begins making payments on the new, larger mortgage.
Who Should Get a Cash Out Refinance?
- Homeowners with significant equity built up in their property
- Those needing funds for major home improvements or renovations
- Individuals looking to consolidate high-interest debts
- People seeking to invest in a business or education
- Homeowners with a strong credit score and stable income
- Those who plan to stay in their home long-term
While these are the ideal circumstances for this type of refinance, borrowers should address cash out refinance pros and cons before pursuing this program.
Cash Out Refinance Pros
First, let’s start with the more positive aspect of cash out refinance pros and cons.
Lower Interest Rates
For the first of the cash out refinance pros, cash out refinances often come with lower interest rates compared to other forms of borrowing, such as personal loans or credit cards. This is because the loan is secured by your home, reducing the risk for lenders. Lower interest rates mean you’ll pay less over the life of the loan, potentially saving thousands of dollars.
If you obtained your original mortgage when rates were higher, a cash out refinance could allow you to lock in a lower rate, reducing your monthly payments even as you borrow more. This can be particularly advantageous in a low-interest-rate environment.
Access to Large Sums
The next of the cash out refinance pros is that it allows homeowners to access a significant amount of money in one lump sum. This can be particularly useful for funding large expenses or investments that require substantial capital upfront.
The amount you can borrow is typically larger than what you might get through other lending options, as it’s based on your home’s equity. This makes cash out refinances an attractive option for major home renovations, starting a business, or funding higher education.
Potential Tax Benefits
The third of the cash out refinance pros is that the interest paid on a cash out refinance may be tax-deductible, particularly if the funds are used for home improvements. This can lead to significant tax savings, effectively reducing the cost of borrowing.
However, it’s important to consult with a tax professional, as tax laws can change and the deductibility depends on various factors, including how you use the funds and your overall tax situation.
Debt Consolidation
Next on the cash out refinance pros is that they can be an effective tool for consolidating high-interest debts. By using the cash to pay off credit cards, personal loans, or other high-interest debts, you can potentially save money on interest and simplify your finances with a single monthly payment.
This strategy can help improve your credit score over time by reducing your credit utilization ratio. However, it’s also important to address the underlying spending habits that led to the debt in the first place to avoid running up new balances.
Home Improvement Funding
The last of the cash out refinance pros is that using a cash out refinance for home improvements can be a smart financial move. Not only can you potentially increase your home’s value, but you’re also reinvesting in your property, which can lead to long-term appreciation.
Moreover, unlike personal loans or credit cards, the interest on a cash out refinance used for substantial home improvements may be tax-deductible, making it a cost-effective way to fund renovations.
Cash Out Refinance Cons
Now, let’s discuss the less-than-favorable side of cash out refinance pros and cons, the cash out refinance cons.
Increased Debt
The biggest of the cash out refinance cons is that your overall mortgage debt increases. While you receive cash in hand, you’re essentially borrowing more money against your home. This means you’ll have a larger loan to repay over time, which can be a significant long-term financial commitment.
If you’re not disciplined with the cash you receive, you might find yourself in a worse financial position. It’s crucial to have a solid plan for the funds and to avoid using them for non-essential expenses.
Higher Monthly Payments
Next for the cash out refinance cons is that despite potentially lower interest rates, your monthly mortgage payments may increase due to the larger loan amount. This can strain your monthly budget and potentially lead to financial stress if your income changes or you face unexpected expenses.
It’s important to carefully consider whether you can comfortably afford the new payments over the long term, especially if you’re extending the loan term.
Closing Costs
The final of the cash out refinance cons is that like any refinance, a cash out refinance comes with closing costs. These can typically range from 2% to 5% of the loan amount and include fees for appraisals, title searches, and other administrative expenses.
These costs can eat into the cash you receive, reducing the effective amount you’re borrowing. In some cases, the closing costs might outweigh the benefits, especially if you’re only accessing a small amount of cash.
Cash Out Refinance Alternatives
- Home Equity Line of Credit (HELOC): A HELOC provides a revolving line of credit based on your home’s equity. You can borrow as needed up to a set limit; one of the major pros is that you only pay interest on what you use. Requirements typically include a good credit score (usually 620 or higher), a debt-to-income ratio below 43%, and sufficient home equity (usually 15-20% or more).
- Home Equity Loan: Also known as a second mortgage, this option provides a lump sum loan based on your home equity. Pros include that home equity loans usually have a fixed interest rate and there is a set repayment term. Requirements are similar to HELOCs, including good credit, low debt-to-income ratio, and sufficient equity.
- Reverse Mortgage: For homeowners aged 62 or older, a reverse mortgage allows you to borrow against your home’s equity without monthly payments. The loan is repaid when you sell the home, move out, or pass away. Requirements include being 62 or older, having significant home equity, and completing a financial assessment.
Cash Out Refinance Lenders
1. QuickLoan Financial
QuickLoan Financial is known for its streamlined cash out refinance process, leveraging technology to provide fast approvals and closings. They offer competitive rates and a variety of loan terms to suit different financial situations. Their online platform allows borrowers to track their application status in real-time and upload documents securely.
What sets QuickLoan apart is their dedicated team of refinance specialists who guide borrowers through the entire process. One of their pros is that they also provide a unique “Rate Lock Guarantee,” ensuring that borrowers get the rate they’re quoted, even if market rates increase during the application process.
2. Defy Mortgage
Defy Mortgage is bringing some bold, innovative energy to the mortgage game for non-traditional borrowers. Their experienced team specializes in helping real estate investors build their empire and establish their legacy with tailored loan solutions customized to meet each investor’s unique needs. They break down barriers for both buying and refinancing, making the process smoother and more secure.
That cookie-cutter, one-size-fits-all approach? Not their style. Defy knows that access to the right mortgage can make or break a project. They’ve seen firsthand that the banks are rigid – many of Defy’s employees worked there for years. It’s why Defy was started – they are driven by a passion to challenge the status quo and create a new era of lending that puts the power in the hands of borrowers. Talk about setting new standards in the industry.
Defy’s CEO, Todd Orlando, is an experienced banker who isn’t afraid of defying the traditional in the financial services space. Recognizing that the number of self-employed individuals is at an all-time high, Defy offers 75+ creative loan programs to help non-traditional borrowers achieve their goals – and that includes DSCR, fix & flip loans, construction loans and more. And the biggest pro of all? They close fast and make it easy.
3. HomeTrust Mortgage
HomeTrust Mortgage specializes in cash out refinances for a wide range of property types, including single-family homes, condos, and multi-unit properties. They’re known for their flexible underwriting criteria, which can be beneficial for self-employed borrowers or those with less-than-perfect credit.
One of HomeTrust’s standout features is their “Equity Maximizer” program, which allows qualified borrowers to access up to 90% of their home’s value in certain cases. They also offer free consultations with financial pros to help borrowers make informed decisions about using their home equity.
4. Wells Fargo
As one of the largest banks in the U.S., Wells Fargo offers a comprehensive range of cash out refinance options. They’re known for competitive rates and have a vast network of local branches for borrowers who prefer in-person service. Wells Fargo also offers unique benefits for existing customers, such as relationship discounts.
One of Wells Fargo’s distinguishing pros is their “yourLoanTracker” service, which allows borrowers to securely upload documents, check application status, and communicate with their loan officer online. They also offer a “Rate Lock” option for up to 120 days, which can be beneficial in a fluctuating rate environment.
5. Rocket Mortgage
Rocket Mortgage, part of Quicken Loans, is known for its user-friendly online platform and mobile app, making the cash out refinance process highly accessible. They offer a range of refinance options and are known for their quick closings, sometimes in as little as 8 days.
A notable pro of Rocket Mortgage is their “YOURgage” program, which allows borrowers to choose any loan term between 8 and 29 years. This flexibility can be particularly useful for cash out refinance borrowers looking to balance access to equity with manageable loan terms.
Pros and Cons of Cash Out Refinance Conclusion
The pros and cons of cash out refinance is a crucial topic for homeowners to understand before making any financial decisions relating to refinancing your home. While a cash out refinance can offer immediate access to funds and potentially lower interest rates, it’s important to carefully weigh the long-term implications.
Before making a decision, homeowners should thoroughly research the pros and cons of cash out refinance and consult with financial advisors to determine if this option aligns with their specific financial goals and circumstances.
Let us quickly recap what we learned in the pros and cons of cash out refinance blog. The pros for a cash out refinance are as follows:
- Lower Interest Rates
- Access to Large Sums
- Potential Tax Benefits
- Debt Consolidation
- Home Improvement Funding
While the cons for a cash out refinance are as follows:
- Increased Debt
- Higher Monthly Payments
- Closing Costs
To reiterate once more, it’s crucial for homeowners to carefully consider their financial situation, long-term goals, and the current market conditions before deciding on a cash-out refinance.
Consulting with financial advisors and mortgage professionals – hint: lenders like us at Defy – can help in making an informed decision that aligns with individual circumstances and objectives.
Pros and Cons of Cash Out Refinance FAQs
- What is a cash out refinance?
A cash out refinance is a type of mortgage refinancing where you replace your existing mortgage with a larger loan and receive the difference in cash.
- How does a cash out refinance work?
You take out a new mortgage for more than you owe on your current mortgage, pay off the existing loan, and receive the excess funds in cash.
- How long does a cash out refinance take?
The process typically takes 30 to 45 days, similar to a standard mortgage refinance.
- Who is a cash out refinance good for?
It’s suitable for homeowners with significant equity who need funds for major expenses like home improvements, debt consolidation, or education costs.
- What are the cash out refinance pros?
Cash out refinance pros include access to large sums of money, potentially lower interest rates, possible tax benefits, and the ability to consolidate debt.
- What are the cash out refinance cons?
Cash out refinance cons include increased overall debt, potentially higher monthly payments, closing costs, increased risk of foreclosure, and reduced home equity.
- What are some alternatives to a cash out refinance?
Alternatives include home equity loans, home equity lines of credit (HELOCs), personal loans, and credit cards.
- Who can help me get a cash out refinance?
Many lenders offer cash out refinances, including banks, credit unions, online lenders, and mortgage brokers. Each lender’s program has cash out refinance pros and cash out refinance cons, so it’s important to address these before making any financial decisions.
