When interest rates are low, we usually start to hear more about the possibility of refinancing a mortgage. Homeowners may find themselves wondering, “Is it a good idea for me to refinance my mortgage? Or should I leave it as is?”
First, let’s cover the basics of what conducting a cash-out refinance entails.
You’ll get a new loan at a lower interest rate, borrowed against equity built up in your home. Then you’ll receive the difference between your new mortgage (with a higher outstanding balance) and your former mortgage in cash — and, of course, it’s up to you how you use those funds. The amount you withdraw depends on how much equity you’ve built up; keeping in mind you’re generally required to keep a certain percentage of equity in place as a cushion.
As is true of any major financial decision you’ll make in your lifetime, there are both pros and cons to consider. Knowing the possible upsides and downsides ahead of time will help you make a sound decision.
Potential Benefits of a Cash-Out Refinance
The flexibility of the cash-out refinance makes it a potential avenue for homeowners needing cash for a variety of causes. Here are some common reasons people utilize cash-out refinances, according to Bankrate:
- Funding home improvements or repairs that’ll add value to your home.
- Using a cash-out-refinance to pay off debt with higher interest rates, like credit cards or medical bills.
- Paying for a major expense like college tuition for a child.
- Reducing the amount of interest they’re paying over time on their mortgage.
Essentially, cash-out refinances offer homeowners with equity a flexible way to get their hands on a lump sum of cash at a lower interest rate than other forms of borrowing — like student loans, personal loans and credit cards.
Potential Risks of a Cash-Out Refinance
So far, cash-out refinances sound pretty good. Now let’s cover the potential risks of going this route so you’ll avoid its pitfalls.
Anytime you’re offering up your home as collateral, there’s a risk you’ll face foreclosure if you fall behind on payments for any reason. As the experts at MarketWatch note, it’s generally viewed as risky to use secured debt to pay off unsecured debt— i.e. increase your mortgage to pay off credit cards/medical bills. It can absolutely save you money, but you need to be sure you can be consistent on mortgage payments for as long as it takes to fulfill your obligation. The worst-case scenario here would be losing your home.
Just like the first time around on your mortgage, you’ll have to again contribute closing costs. These are expressed as a percentage of the new mortgage. You can expect to pay about $2,000 to $5,000 per $100,000 loan, which means it’s important to weigh this expense against how much you could potentially save through refinancing for a lower interest rate.
Cash-Out Refinancing: The Verdict
So, when is a cash-out refinance a good idea? Make sure you’ll be saving money thanks to a lower interest rate and accomplishing a worthwhile financial goal with the cash sum you receive.
It’s only a good idea if you can commit to paying off an increased mortgage over the course of many years to come, lest you risk losing your house down the line. Finally, if you’re refinancing for the purpose of paying down problem debt, make sure you have a plan in place to avoid racking up credit card balances again in the future; to repeat the problem would make the cash-out refinance a moot point.
