When you refinance your mortgage, you may be able to choose to receive some of your home equity in cash. This is called a "cash-out" refinance. While a cash-out refinance may have some advantages, there are also some significant disadvantages that you should be aware of before you decide to go this route.
Advantages of a Cash-Out Refinance
You may be able to get a lower interest rate. If interest rates have gone down since you originally took out your mortgage, you may be able to get a lower rate by refinancing.
You may be able to shorten the term of your loan. If you originally took out a 30-year mortgage, you may be able to refinance into a 15- or 20-year loan and pay off your mortgage more quickly.
You can use the equity in your home to consolidate other debts. If you have high-interest debt such as credit card debt, you may be able to get a lower interest rate by refinancing your mortgage and using the equity in your home to pay off the other debt.
Disadvantages of a Cash-Out Refinance
You may end up paying more interest over the life of the loan. If you take out a cash-out refinance and keep the same term as your original mortgage, you will end up paying more interest over the life of the loan because you are essentially starting over with a 30-year loan (or whatever the term of your mortgage is).
You could end up owing more than your home is worth. If housing prices go down, you could end up owing more on your mortgage than your home is worth. This is called being "underwater" on your mortgage.
You may have to pay private mortgage insurance (PMI). If you don't have a lot of equity in your home, you may have to pay PMI. This is an extra monthly fee that you have to pay, and it can add up over time.
You may have to pay closing costs. When you refinance your mortgage, you may have to pay closing costs, which can add up to several thousand dollars.
Before you decide to do a cash-out refinance, make sure you understand all of the potential disadvantages so that you can make an informed decision.