A cash-out refinance replaces your current home loan with a new mortgage for more than your outstanding loan balance. You withdraw the difference between the two mortgages in cash and put the money toward home remodeling, consolidating high-interest debt or other financial goals.
Reasons to use a cash-out refinance
There are many advantages to using a cash-out refinance over other types of loan products if you need a large sum of money. Here are some common reasons to use a cash-out refinance:
- Get a lower interest rate on their mortgage. This is the most common reason why most people do a traditional refinance, and it makes sense for cash-out refinancing, too, because you’ll be taking on a larger loan and lowering your interest costs.
- Make value-added home improvements or repairs to your home. Homeowners who use cash-out refis for these type of projects can deduct the mortgage interest from their taxes. Also, tapping your home’s equity could be less expensive than other forms of financing, such as a home equity loan, personal loan or credit cards.
- Consolidate and pay off high-interest debt.
- Help pay for the down payment on your new home if you qualify for both mortgages.
Risks of using a cash-out refinance
Cash-out refinancing isn’t always the best move for every situation. Here are some reasons to avoid a cash-out refinance:
- Increases the interest rate of your existing mortgage. A general rule of thumb is to refinance to improve your financial situation and get a lower rate. If cash-out refinancing hikes your rate significantly, it may not be a wise move.
- Drags out the repayment of an existing debt for decades. If you’re using a cash-out refinance to consolidate debt, make sure you’re not prolonging debt repayment over decades when you could have paid it off much sooner and at a lower total cost otherwise.
- Heightens risk of losing your home. No matter how use you use a cash-out refinance, failing to repay the loan means you could wind up losing it to foreclosure. So don’t take out more cash than you absolutely need and ensure you’re using it for a purpose that will improve your finances instead of worsening your situation.
- Tempts you to use your home as a piggy bank. Tapping your home’s equity to pay for lavish vacations or purchases indicates a lack of discipline over your spending habits. It’s a place to live and not your personal ATM. If you’re struggling with getting your debt or spending habits under control, consider seeking help through a nonprofit credit counseling agency.
Blackrock Investments and Finance, Inc.
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