Cash-out refinancing may be unfamiliar to you, but it’s a concept you might want to explore if you’d like to take advantage of the equity you’ve built up in your home. Equity is the difference between your home’s value and the amount that you owe on your mortgage. Your equity grows over time as you pay down a mortgage balance, or as your home increases in value. Unlike traditional refinancing, in which you generally swap your existing mortgage balance for a new loan, a cash-out refinance replaces your existing loan for one in an amount greater than your current balance.
Here’s an example:
Suppose your mortgage balance is $200,000 and your home is valued at $400,000. That means you have $200,000 equity in your home. A lender may be willing to refinance your mortgage balance of $200,000, plus a certain percentage of your equity which you could use for any purpose.*
Let’s say you are approved to use a cash-out to refinance the remaining $200,000 balance on your mortgage plus 50% of your equity. Your new loan would be for $300,000, of which you could receive $100,000 in cash. You now have $100,000 in equity in your home instead of $200,000, based on a home value of $400,000 minus your new loan balance of $300,000.
Why Use a Cash-Out Refinance?
A cash-out refinance may make sense if you have a significant amount of equity in your home and you want to free up the money for other purposes. It may be favorable if:
- Current mortgage rates are lower than the rate on your existing mortgage. (Note that interest rates on cash-out refinances are typically higher than rates on traditional refinancing.)
- You plan to use the equity to pay for home improvements that increase the value of your home.
People may use cash-out refinancing for college tuition, to pay off high-interest-rate debt, or launch a new business.
Research the Costs and Cons
As with traditional refinancing, you’ll need to compare the rate you are paying on your existing loan with currently available rates. There may also be upfront closing costs, such as appraisals, attorney fees, application fees, title search, and insurance.
Keep these factors in mind:
- By taking out a larger loan, your overall monthly payments may be significantly higher, even at a lower interest rate.
- If you fail to make timely payments, you are putting your home at risk of foreclosure.
- As with any loan, if the market value of your home falls when you sell it, you still need to repay the mortgage balance.
Consider These Alternatives
If you’d like to consider some alternatives before signing off on a cash-out refinance, DCU offers other loan products with great rates:
Home Equity Loan or Line of Credit. A home equity loan allows you to take out a lump-sum based on the equity in your home, usually at a fixed rate. A home equity line of credit, or HELOC, is a more flexible option. You can withdraw funds from your approved line of credit as needed, according to the loan terms. A HELOC is usually offered as a variable rate loan. As with a refinance, home equity loans and HELOCs are secured by your home and can come with similar risks, such as foreclosure if payments are not made.
Personal Loan. Although a personal loan generally carries a higher interest rate than mortgage loans or home equity loans, a personal loan may be a better option for large purchases or vacations.
Mortgage Modification. If you’re considering refinancing to modify the terms, interest rate, or type of your current mortgage loan due to financial or personal hardship, look into a Mortgage Modification. While refinancing replaces your mortgage with a new one, a modification changes the terms of the mortgage you already have.
Whatever your reasons for refinancing, be sure to review all your options to help ensure you are making a good financial decision.
*Cash-out refinancing is generally limited to about 80% of the equity in your home but may be more or less, depending on the lender. Loan-to-value calculations also will affect the amount a lender may be willing to include in a cash-out refinance. The usual loan considerations, such as creditworthiness, apply.
This article is for informational purposes only. It is not intended to serve as legal, financial, investment or tax advice or indicate that a specific DCU product or service is right for you. For specific advice about your unique circumstances, you may wish to consult a financial professional.
