Cash-Out Refinance refers to replacing an existing mortgage with a new, higher loan, with the difference paid out in cash.
You can then use this cash for home improvements, paying off existing high-interest credit card debts, or other expenses. The amount of the cash-out loan depends on your credit score, loan-to-value (LTV) ratio, and existing mortgage and can be up to 80 percent of the value of the house. To qualify for this new mortgage, however, you must have built up equity in your home. And even though the required credit score is usually lower than that of other refinance options, you should expect to have a score of over 620.
Advantages of Cash-Out Refinance
Taking out a new loan should always be well-considered, and the advantages and disadvantages weighed up. What better reason could there be than to save money?
Here are the most important pros of cash-out refinance to help you make a decision:
Opportunity of Debt Consolidation
Basically, refinancing makes sense if you can lower the interest rate on your existing loan by at least one to two percent. Consolidating other loans with a low-interest mortgage rate might also make sense but should be discussed with a financial advisor beforehand. In most cases, debt consolidation with a personal loan makes more sense.
Get Cash Out
One of the advantages that the cash-out refinance offers over other refinances is, as the name suggests, the cash you receive. What the money is used for is ultimately up to you.
However, since every form of loan has an impact on your financial situation, you should be clear about what you are using the money for. It is obvious that investing in tuition or home improvements, for example, is more worthwhile than investing in a sports car.
Improve Your Credit Score
Along with paying off existing debt, your credit score increases as well. For example, you can use the cash from a cash-out refinance to pay off your high-interest credit card debt. This way, you can reduce your credit utilization score, which has a big impact on your credit score.
Reinvesting in Your Home Pays Off
By reinvesting cash in repairs and renovations, you can increase the value of your home immensely. But make sure to focus on value-adding improvements. Lining the house with insulation, for example, has a particularly high return on investment and can be worthwhile for you. Second, your home improvements might be tax-deductible, saving you more money in the long run.
Why Cash-Out Refinance Could Be a Bad Idea
Whether the advantages of this mortgage refinancing apply to you depends strongly on some personal factors. Before you decide on this refinancing option, you should look at the disadvantages, too, to see if you can benefit from it or not.
Closing Costs and Other Fees
As with any other refinancing options, cash-out refinance also incurs closing costs, fees for taking out legal protection, insurance, and application fees. It is therefore important to make sure that the potential savings from refinancing exceed the costs. Depending on the lender, the closing alone may cost up to five percent of the mortgage.
Negative Impact on Your Credit Score
Generally, a hard credit inquiry is required when applying for a cash-out refinance. Even if the impact of a hard credit check on your credit score is usually very small, you should be aware of the consequences. Even a slight, temporary drop in your credit score can stand in the way of a new loan.
Which is Better: Cash-Out Refinance, Home Equity Loan, or HELOC?
We already have discussed the advantages and disadvantages of a cash-out refinance. But how does it compare to a home equity loan or HELOC?
|Cash-Out Refinance||Home Equity Loan (HELOAN)||Home Equity Line of Credit (HELOC)|
|Credit Score||620 or higher||620 or higher||680 or higher|
|Loan Amount||80-85% of the house value minus mortgage||80-85% of the house value minus mortgage||80-85% of the house value minus mortgage|
|Closing costs||2-5 % of mortgage||2-5% of total loan costs||2-5% of total loan costs|
|Monthly Payments||fixed-rate||fixed-rate||variable depending on the amount you draw|
|Loan Payment||Part of the refinancing will not be paid out and the cash-part in a lump sum.||lump-sum||revolving credit|
|Annual Percentage Rate (APR)||slightly lower than a home equity loan||slightly higher than cash-out refinance and HELOC||slightly lower than home equity loan and only on the amount you draw|
You still cannot decide whether a cash-out refinance or another option is best for you? For a comparison of HELOC and home equity loans with a personal loan, click on the link.