Thinking About Cash-Out Refinancing? Read This First
Cash-out refinancing can be a great strategy for getting cash out of your home, but it’s important to understand how to use it to your best advantage.
Basically, cash-out refinancing is when you take out a new mortgage with a larger principal than your current mortgage. The goal is often twofold: to get a lower interest rate and to turn your home equity into cash that you can use.
Here are some smart - and smarter - ways to use cash-out refinancing:
Smart: Use cash-out refinancing for home improvement and maintenance.
It’s a lot like a company re-investing profits to maintain or grow the business (and get more profits). By taking some of the equity in your home and reinvesting it in home improvement projects, you can help to maintain the value of your home, and maybe even increase it.
Smarter: Do your homework.
Make sure the improvement you are making will increase your home’s value in proportion to the investment. A new roof, for example, is an important part of your home’s upkeep and is necessary for ensuring your home’s continued value. A new kitchen can also be a sound investment. A swimming pool, on the other hand, might be something to consider more carefully. Pools tend to be expensive to build and maintain and may not pay you back when you go to sell.
Smart: Use cash-out refinancing for debt consolidation.
Mortgages generally carry much lower interest rates than credit cards, so by using a cash-out refinance to pay off your credit card debts, you may be able to decrease how much you pay in the long term. In addition, because mortgage payments are spread out over so many years, the monthly payment burden is often considerably less. Even better, the interest on your new mortgage may be tax-deductible, unlike the interest you pay on credit cards.
Smarter: Cut up your credit cards once you’ve paid them off.
Those beautiful zero balances on your credit card statements don’t mean you’ve removed your debt; you’ve just shifted it into your mortgage. All that financial good sense will be wiped out if you run up more debt. And remember, now your house is on the line too – if you get default on your loan, you could lose your home.
Smart: Use cash-out refinancing when you need a large sum of cash.
College tuition, another property, a large medical bill. These are all big expenses for which cash-out refinancing may make sense. The same benefits apply: much lower rate than other types of loans or credit cards, and the interest is tax deductible.
Smarter: Consider the expenditure carefully.
Even though a cash-out refinance can be a relatively painless way of getting cash, it’s still spending money. It’s just like a savings account: if you spend it now, you won’t have it later. And, again, if you default on the loan, you could lose your home.
One final consideration:
If current interest rates are higher than your existing mortgage, or you don’t plan to be in your home much longer consider a home equity loan or line of credit instead. See our section titled Using Your Home Equity.
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