Turn Your Equity Into Cash
Refinancing with cash-out substitutes your current mortgage with a new, bigger loan. The difference between your new and old loan amounts is returned to you in cash at closing. The money can be used for anything, from home upgrades to debt consolidation, but some applications are more logical than others.
This is a common method for homeowners to access their equity, generally up to 80%. In addition, it is a method for gaining access to big sums of money at low-interest rates. If you are eligible for cash-out refinancing and use the funds carefully, you may significantly improve your portfolio.
How Cash-Out Refinancing Works
Like other refinance programs, a cash-out refinance replaces your old mortgage with a new one, presumably with a reduced interest rate. The difference with a cash-out refinance is that your new loan sum will be more than your current mortgage balance. You will repay your current mortgage lender with the funds from the new, larger loan. You will retain the increased funds from the new loan. This excess cash is your “cash out.”
The following is an example of a cash-out refinancing:
- Currently outstanding mortgage balance: $250,000
- loan sum after refinancing: $280,000
- Cash-out: $30,000 (minus closing costs)
Remember that you can only use cash-out refinancing to extract some of your equity. Typically, lenders demand homeowners to retain at least 20% equity in their houses, limiting the amount that may be cashed out.
Six Examples of Cash-Out Refinancing
Homeowners in the United States cash out their equity for various reasons, and there are no restrictions on how to spend the money. Nevertheless, certain applications are “better” and more economically sensible than others.
Most mortgages, including cash-out refinancing loans, have 30-year loan durations, and interest is accrued full-time. Therefore, there are better ideas than using this long-term debt to support short-term requirements.
For instance, most finance pros would not propose financing a costly trip with a 30-year mortgage. You would be paying for the trip for decades. It would help if you also thought hard about utilizing a cash-out refinance to purchase a car since its worth will only decrease. And you may continue to pay interest even after the vehicle has been sold.
Here are some of the most effective ways to utilize cash-out refinancing money.
Complete Home Renovation Projects
Using cash-out refinancing to finance a home repair project should be a wise investment for most homeowners. Adding a master bedroom suite may cost $100,000 or more; renovating a kitchen could cost $60,000 or more, and renovating a bathroom could cost $50,000 or more.
But these renovations also increase the value of your property, so you’re not simply spending money; you’re also boosting your real estate investment. Cash-out refinancing is a viable option for funding these costly home improvements.
A home equity loan or line of credit (HELOC) may provide superior alternatives for smaller projects. With these loans, you maintain your existing mortgage and use a smaller loan to access your home equity.
Repaying High-Interest Credit Card Debt
Cash-out refinancing loans can be helpful in paying off a substantial amount of high-interest debt, such as credit card accounts or personal loans. Because a mortgage is a secured loan, it can provide lower interest rates than the unsecured personal loans that consumers frequently utilize to repay current debt.
Interest rates on credit card debt can exceed 20%, although home debt is still around 10%. A substantial amount of interest can be avoided, and your monthly payments can also be drastically reduced. Here is a typical technique for refinancing to eliminate credit card debt:
Utilize cash-out refinancing funds to settle any outstanding credit cards.
Use the money you were paying on credit card debt to pay down the main balance of your home loan each month, in addition to your usual mortgage payment.
In this manner, homeowners may save hundreds, if not thousands, of dollars and reduce their overall debt burden. And with this approach, you would gain momentum each month as your balance decreases.
This is known as debt consolidation. It only works if you maintain low credit card balances in the future after paying off your cards. We do not suggest this technique for refinancing student loan debt since there are more cheap solutions and because federal student loans include flexible repayment options that a new mortgage cannot give.
Protect or Add to Your Current Investments
Refinancing with cash-out might also improve your investment portfolio. Numerous investments provide higher returns than the cost of a home equity loan. If you need cash but don’t want to liquidate current investments, such as retirement savings or certificates of deposit, accessing your home’s equity may be a less expensive alternative.
Additionally, many investment products might help you save money on income taxes. Investing in an IRA or 529 College Savings plan can reduce your taxable income to a certain extent.
Cash-out refinancing can also help you diversify your holdings or protect you against a decline in the home market. However, investments with a greater yield than mortgage rates are often riskier than those with a fixed or guaranteed income.
Before implementing this technique, consult a reputable financial adviser to ensure that you take advantage of tax deductions and planning for the future.
Purchase a Rental Property
You might utilize the funds from refinancing your home residence to purchase rental or investment property. As an asset type, real estate may generate wealth rapidly due to the ability to leverage purchases. For example, with a 10% down payment ($50,000), you might control $500,000 in real estate. A 5% increase on a $500,000 property generates an additional $25,000 wealth. That would yield a 50% return on your initial cash investment of $50,000.
In comparison, a 5% return on $50,000 invested in equities provides just $2,500 in additional value.
This is an excellent method for expanding your real estate holdings. Often, homeowners take out a cash-out mortgage and use the proceeds to purchase a rental property. When they wish to reinvest, they do a cash-out refinancing on their existing investment property to acquire a second investment property. The final result is a healthy portfolio of rental properties that provide recurring revenue and have traditionally maintained their value.
Purchase a Second House
If you’re not interested in being a landlord but desire another house, you may sell your primary dwelling and use the proceeds to purchase a second home (vacation property). You may own a family vacation home with as little as a 10% down payment. No scheduling headaches, no exorbitant hotel costs, and the option to rent the property while you’re not using it.
Today’s rising property values make it easier to save enough money for a down payment on a second home. Vacation house prices are also increasing.
If your cash-out refinance needs to generate more funds to purchase a second house, you should aim for a 20% down payment on the new property to avoid private mortgage insurance (PMI) payments. Remember that FHA and VA loans cannot be used to finance a second property; therefore, you will require a conventional mortgage.
Protect a Company Against Cash-Flow Issues.
Cash-out refinancing can serve as a low-cost source of emergency liquidity if you have an existing firm or a startup. Have you heard the adage that banks only lend money to those who don’t need it? There is considerable validity to the proverb.
Therefore, liquidate your stock before your firm encounters cash flow issues that jeopardize your ability to borrow money. Your interest rate is also likely lower if your financial status, income, and credit score are all satisfactory.
This is an excellent method for expanding your real estate holdings. Often, homeowners take out a cash-out mortgage and use the proceeds to purchase a rental property. When they wish to reinvest, they do a cash-out refinancing on their existing investment property to acquire a second investment property. The final result is a healthy portfolio of rental properties that provide recurring revenue and have traditionally maintained their value.
How Much Cash Can I Pull Out?
The amount you may cash out depends on the value of your house and your mortgage balance. Typically, the refinanced loan amount cannot exceed 80% of the home’s value; however, certain VA cash-out loans permit up to 100% financing.
If your property is worth $350,000 and you owe $250,000 on your mortgage, you have $100,000 in equity. This illustration implies that you do not have a second mortgage. However, you will not receive a $100,000 check at closing.
First, the lender will determine 80% of the home’s worth or $280,000 in this example. This is the maximum loan amount for your mortgage refinancing. This is sometimes referred to as the maximum loan-to-value (LTV) ratio.
When you refinance, the new loan (for $280,000) will pay off your old loan debt of $250,000. Using a cash-out refinancing, the maximum amount you may withdraw is equal to the remaining equity, which in this example is $30,000.
However, pay attention to closing charges. If your closing fees are $5,000, your final check will be $25,000. Still a good asset but worth just a fifth of the $100,000 in home equity you have accumulated.
What Are the Alternatives to Cash-Out Refinancing?
Refinancing with cash-out offers you access to your home’s equity while replacing your existing mortgage loan with a new one. If your current mortgage still has an adjustable rate, your new loan might have a shorter loan term, a lower interest rate, or a fixed rate. If you can afford the higher monthly payment, shorter, fixed loan periods might save you hundreds of dollars in interest over the life of the loan.
However, what if you currently have an excellent fixed interest rate and wish to keep your loan term the same? Can you access your home’s equity while maintaining your current loan and making payments as scheduled? Yes. Here are two possibilities for a cash-out refinance.
- A home equity loan allows you to borrow a lump sum based on the value of your property. You will continue to make your current monthly mortgage payments and a new payment for the new loan.
- HELOC: home equity line of credit. Your accessible home equity can fund a revolving line of credit from which you can borrow, repay, and use again. Typically, HELOCs have variable interest rates.
These loans make sense if you already have a mortgage with a competitive interest rate or if you are so far along in the repayment of your current mortgage that it would not make sense to start again.
Loan amortization schemes need more interest payments in the loan’s first years. 15 years into a 30-year loan, you may have already paid off the majority of the interest. Even with a reduced interest rate, establishing a new amortization schedule on a mortgage refinancing might cost more than keeping the old mortgage. In this situation, a home equity loan or home equity line of credit (HELOC) may work effectively.
Do I Qualify for a Cash-Out Refinance?
To obtain cash from your property’s worth, you must:
- Have a sufficient amount of home equity.
- Obtain approval for a cash-out refinancing loan.
- Pay closing expenses.
Let’s examine these three criteria independently.
You Must Have Sufficient Home Equity to Cash-Out Refi
You increase your home’s equity once you make a monthly mortgage payment. Concurrently, home value appreciation increases your equity. Consequently, if you owe $100,000 on a property worth $200,000, you have $100,000 in equity.
However, this does not imply that you might withdraw the whole $100,000 in cash from your property. For FHA and conventional loans, cash-out options require you to retain at least 20% of your equity. That’s $40,000 you cannot cash out on a $200,000 property.
This would allow you to borrow up to $60,000, less closing fees.
Leaving 20% in equity might be restrictive for borrowers with two mortgages. For example, let’s review the case in which you owe $100,000 on a $200,000 property for which you owe $200,000.
After leaving the remaining 20% ($40,000) in equity alone, you would have $60,000 in equity against which to borrow. However, if you also had a $40,000 home equity line of credit, your cash-out refinancing would be limited to $20,000 minus closing fees.
Lenders impose these loan-to-value ratio limitations to mitigate their risk should you default on your new mortgage. If the bank were to initiate foreclosure procedures, the 20 percent equity in your property might absorb a significant portion of its losses. Only a VA cash-out loan, available to veterans and active-duty military personnel, would allow you to access your equity while refinancing your primary mortgage.
You Must Satisfy Cash-Out Refinancing Requirements
Your ability to obtain financing depends on your credit score and debt-to-income ratio (DTI).
Refinances with cash-out tend to have stricter credit standards than initial mortgage loans. Some creditors accept FICO ratings as low as 620, while others may demand 640, 660, or higher.
You’ll need a new home appraisal to confirm that the property’s current worth is sufficient to support the cash-out loan.
You must have a stable income and a job.
See your loan officer if you have issues regarding your capacity to borrow or repay the loan.
You Must Pay Closing Expenses
Like your original mortgage, cash-out refinancing loans require you to pay closing costs. Since the property will not be sold, the expenses may be lower than your original mortgage. However, you would still be responsible for loan origination expenses, an appraisal, and legal fees.
You may be able to finance these fees into your new mortgage loan, but you will pay higher interest over time. Many borrowers intend to utilize a portion of their cash-out to cover closing costs, but this has the same net impact as including the closing costs into the new loan.
