What it is and when to use it
If you have a significant amount of equity built up in your home and would like to convert that equity into actual money you can use, a cash out refinance may make sense for you. Here are some of the key things you should know.
What is a cash out refinance?
A cash out refinance is when you take out a new home loan for more money than what you owe on your current loan and receive the difference in cash. For example, if your home is worth $300,000 and you owe $200,000, you have $100,000 in equity. With cash out refinancing, you could receive a portion of this equity in cash. If you wanted to take out $40,000 in cash, this amount would be added to the principal of your new home loan. In this example, the principal on your new mortgage after the cash out refinance would be $240,000.
When is a cash out refinance a good option?
A cash out refinance makes sense in a number of situations:
- When you have the opportunity to use the equity in your home to consolidate other debt and reduce your total interest payments each month
- When you are unable to get other financing for a large purchase or investment
- When the cost of other financing is more expensive than the rate you can get on a cash-out refinancing
What can I use the cash for?
You are free to use the cash in just about any way you want. Many people use it to pay down high-interest credit card debt. Even though you’ll still owe the same amount of total debt when all is said and done, you can save a lot in monthly interest payments. You may also get the benefit of deducting these interest payments from your taxes, whereas your credit card debt is not tax deductible 1. In this situation, your lender will most likely pay your previous lenders directly at the time of your closing.
Alternatively, some people use the cash for a major purchase or expense if financing is not available or is more expensive than the rate on a mortgage. In this situation, your lender may give you your cash directly to use at your discretion.
Other common reasons for cash out refinancing include:
- Home improvement projects
- Education expenses
- Purchasing an investment property
- Paying for emergency expenses
- Elderly care
Be cautious about using cash-out refinancing or other long-term financing to pay for current or short term expenses. For example, if you use a cash out refinance to pay for a car that you’ll keep for six years, the interest rate will often be much lower than the rate on a new car loan, but you could be paying back the loan for another 24 years. If you use a cash out refinance to pay back credit card debt, you’ll have more credit available on the card, but remember that you still owe the same total amount, or a little more if you finance your closing costs.
Use our Cash Out Refinance Calculator to see how much equity you can take out of your home and estimate how much you’ll reduce your payments by consolidating your existing debt.
1 Consult your tax advisor about the tax deductibility of mortgage interest.