What's in this article?
If you’re facing financial uncertainty and want to reassess your investments, a cash-out refinance might allow you to tap into the money you’ve already paid into your home so that you can use that money toward other life expenses.
To afford your home, you’ve consistently paid down your mortgage. It may feel as if you’re just paying off a debt, but you’re also investing in your home. This investment is something you may be able to tap into as a cash reserve.
How does a cash-out refinance work?
With a cash-out refinance loan, you replace your existing mortgage with a new one that has a higher amount. The new, larger loan pays off your existing mortgage and then pays you the remaining balance in cash.
Because the cash-out refinance loan is larger, it could either include higher monthly payments than your previous mortgage or it will have a longer term to pay down the higher loan amount.
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How much cash can you borrow from your home?
How much home equity do you have?
The more equity you have in your home, the more options you have to use that equity to finance other life expenses. As you’ve paid down your current mortgage, an amount of those payments went to the lender for interest and another amount went toward your principal, building home equity. Home equity is the portion of your home’s value that you own free and clear.
With a cash-out refinance, home equity is important because the amount of cash you can request is typically limited to 80% of your home’s equity, depending on your finances and the type of loan.
Is this the best way to meet your current needs?
Let’s look at a specific scenario to see if a cash-out refinance is right for you. Say your original mortgage amount was for $150,000 to buy your home. You’ve since paid $50,000 of the principal, meaning you have $50,000 in home equity.
With a cash-out refinance, you can potentially borrow up to $40,000 from your home’s equity (80% of $50,000).
If you need $30,000 in cash, you can try to get a cash-out refinance loan for that amount plus the remaining $100,000 you owe on the home. Your new loan amount would be $130,000.
You will receive the $30,000 in cash, which could be the ideal solution for your current financial needs. But you’ll want to make sure you also understand the additional costs you’ll take on in the short and long term.
Are closing costs and new terms affordable?
A new loan comes with multiple considerations that can be more affordable or too expensive, including new terms, interest rates, closing costs, and term lengths.
New terms can be good or bad
Understand the trade-offs of the new terms that come with a new loan. Interest rates are historically low, meaning that although you’re raising the loan amount, you may also lower your interest rate, which could help to lessen the impact of larger costs over time.
Knowing your current terms will also tell you whether you’ll have any penalties for paying off your current mortgage early, and it will allow you to compare the pros and cons of a new cash-out refinance loan.
Closing costs can lower the amount of cash you receive
Each new home loan involves paying closing costs for the processing of the loan. These costs can be about 2-5% of the loan amount. If your cash-out refinance loan is for $130,000 as we used in the above example, the closing costs could be between $2,600 and $6,500.
Make sure that the costs of a new loan don’t eat up too much of the cash you expect to receive. If you need to pay $6,500 in closing costs, that $30,000 in cash, is reduced to $23,500 for example.
Depending on the loan terms you qualify for, you may be eligible for a no-closing-costs loan option where the costs are rolled into the loan amount, to be paid over its lifetime. Although this could also raise your interest rate.
Term length affects monthly payments and long-term cost
Depending on what you qualify for and your short and long term financial needs, you’ll want to consider the pros and cons of each term length.
If the term remains the same as your current mortgage or it’s shortened, you’ll have less time to pay down a larger loan. Your monthly payments will be higher than your original mortgage payments.
If your cash-out refinance loan has a longer term than your original mortgage, this can help to lower your monthly payments. However, it also means that you will pay more interest over the longer lifetime of the loan.
Learn whether you qualify for a cash-out refinance
If the benefits outweigh the risks, refinancing can be a great way to make your equity work for you when you need cash..
The best way to know if a cash-out refinance is right for you is to speak with a loan officer to discuss your needs and the options available to you.
Reach out to us and we can help you get started. Get the most out of your home, while feeling comfortable with your finances.
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