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Personal Finance
4 minute read

In the world of personal finance, the term cash-out refinance is used frequently. But what exactly does it mean, and how does it affect you? This article could help answer these questions and more.

What is cash-out refinance?

A traditional cash-out refinance is a financial strategy where you replace your existing mortgage with a larger loan. The difference between the amounts of the old and new loan is paid out to you in cash, which you can then use toward your financial needs, such as home improvements, debt consolidation, or other expenses.

How does cash-out refinance work?

The amount of cash you can get depends on factors like your credit score, the loan-to-value (LTV) ratio, and your existing mortgage. Typically, you can cash out up to 80% of your home’s value. But remember, to qualify for this kind of refinancing, you need to have built up equity in your home.

Advantages of cash-out refinance

  1. Debt consolidation possibilities

You may lower the interest rate on an existing loan by 1-2% by refinancing. If you have multiple high-interest loans, consolidating them into a single, low-interest loan might be a good option.

2. Access to cash

As the name suggests, cash-out refinance provides cash you can use according to your needs. However, be smart about how you spend this money. Investments in education or home improvement can be more beneficial in the long run than splurging on luxury items.

3. Boost your credit score

You may increase your credit score by paying off existing debt. For instance, you can use the cash from a cash-out refinance to pay off your high-interest credit card debt, which can reduce your credit utilization score considerably.

4. Home improvements pay off

Reinvesting the cash in home renovations may increase your home’s value. Focusing on value-adding improvements can yield a high return on investment. Pro tip—these improvements might be tax-deductible, saving you money in the long run.

Potential drawbacks

  1. Closing costs and other fees

Like all refinancing options, cash-out refinance comes with closing costs, legal protection fees, insurance, and application fees. Ensure the potential savings from refinancing outweigh these costs.

2. Impact on your credit score

A cash-out refinance requires a hard credit inquiry, which can temporarily impact your credit score. Generally, lenders do not do a hard pull unless you’re approved and accept the loan. Even a minor drop in your credit score can hurt your chances of getting a new loan.

Cash-out refinance in comparison

How does a traditional cash-out refinance measure up against other options like a Home Equity Loan (HELOAN) or Home Equity Line of Credit (HELOC)? Let’s have a look.

Cash-Out RefinanceHome Equity Loan (HELOAN)Home Equity Line of Credit (HELOC)
Credit Score620 or higher620 or higher680 or higher
Loan Amount80%-85% of the house value minus mortgage80%-85% of the house value minus mortgage80%-85% of the house value minus mortgage
Closing Costs2%-5% of mortgage2%-5% of total loan costs2%-5% of total loan costs
Monthly PaymentsFixed-rateFixed-rateVariable depending on the amount you draw
Loan PaymentPart of the refinancing will not be paid out and the cash-part in a lump sumLump-sumRevolving credit
Annual Percentage Rate (APR)Slightly lower than a home equity loanSlightly higher than cash-out refinance and HELOCSlightly lower than home equity loan and only on the amount you draw

Cash-out auto refinance

If you don’t have a lot of equity in your home, you can also consider a cash-out auto refinance. Similar to a mortgage refinance, with a cash-out auto refinance you get the equity out of your car and replace it with a loan of higher value. The loan amounts are generally smaller than a traditional cash-out refinance and the funds are paid to you in cash. With a vehicle equity loan, you can get up to 250% of the value of your car, but you must own it outright and it must have a clean title to do so.

This option is beneficial if you have built up significant equity in your vehicle and you need cash for immediate expenses. However, it’s essential to carefully consider the interest rates, terms of the new loan, and impact on your credit score before opting for this. Another potential drawback to this type of loan is that, if you are unable to repay your loan, it’s possible for your vehicle to be repossessed by the lender.

Conclusion

If you decide to move forward with a cash-out refinance or another option, you should carefully consider your financial situation. Remember, even if you don’t own a home, a cash out vehicle equity loan is a potential solution. Weigh the pros and cons and consult with a financial advisor before making a decision. The goal is to make sound financial decisions that enhance your financial stability and future prosperity.

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.


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