Whether you currently have extra time to complete a home improvement project or the recent economic challenges have taken a toll on your family budget, many people are looking for immediate cash these days.
Could a cash-out refinance be the solution?
How It Works
A cash-out refinance is when you refinance your current mortgage for a higher amount than what you owe on your home. You then take the difference between this higher amount and what you actually owe as cash. You receive the cash in one lump sum after your loan closing.
In order for a cash-out refi to be an option for you, your home must have accumulated some equity, which means your home is worth more than what you owe on your mortgage.
For example, let’s say you own a home that would sell (based on appraisal) for $150,000, but you only have $50,000 left to pay on your current mortgage. Since you have accumulated roughly $100,000 in equity, you could refinance your mortgage for $60,000 and receive a lump sum cash payout of $10,000.
While government loans – such as FHA and VA loans – work differently, most conventional mortgages allow you to pull up to 80% of the equity out of your home. This can be a primary residence or second home.
When you initiate a cash-out refinance, the bank will order an appraisal to determine the value of your home. You can take out up to 80% of the home’s equity, based on its appraised value, as cash out.
The interest rate is determined by the amount of the refinance loan verses the value of your home. If you take out 50% instead of 80%, this could give you a lower rate. You will need to add your current mortgage plus the cash you want out to determine the loan-to-value.
Pros & Cons
The main drawback of this solution is that you are paying interest on this cash-out lump sum over the remaining life of your mortgage loan. You can do a cash-out refi for terms of a 30-year, 20-year, 15-year, or 10-year fixed interest rate.
That said, you can usually deduct the interest from a cash-out if you use it for home improvements or to buy another home, like a cottage Up North or a condo in Florida. You should talk to a tax accountant to see if this option is available to you for a deduction.
One big “pro” is that you can use the money for whatever you need. There are no restrictions. Some common uses include:
- Home improvements or repairs
- Building an addition or remodeling to increase the value of your home
- Starting a business or buying an investment property
- Paying for a major life event, such as a wedding or funding your child’s college tuition
You can also use the money to pay off high-interest credit cards or to consolidate debt.
The Best Solution for Your Situation
The pros and cons should also be considered in relation to other options. For instance, you can tap into the equity in your home to get access to quick cash through a home equity line of credit (HELOC) or by taking out a second mortgage on your home, as well.
In comparison, you typically get a lower interest rate and better terms by using a cash-out refinance instead of a second mortgage. Home equity loans can be especially helpful in certain situations, but a HELOC usually does not offer the predictability of a fixed interest rate and will instead fluctuate with the prime rate.
To be clear, all of these options have circumstances that might make them the best alternative, so it is important to talk to your lender to discuss your individual goals.
Contact us at (608) 497-4640 for more information and to discuss your needs.