7 Cash-Out Refinance Considerations | Money Management
A cash-out refinance is a popular way to access the equity in your home. Learn some of the key considerations you need to take before you apply.
When you own a home, one of the most powerful financial tools at your disposal is the ability to refinance your mortgage. Refinancing allows you to access the equity in your home – that is, the difference between your home’s market value and the balance of your mortgage – and use it for other purposes.
A cash-out refinance is one type of refinance transaction that allows you to take cash out of your home equity. In a cash-out refinance, you refinance your existing mortgage into a new one for more than you owe, and you receive the difference in cash.
For example, let’s say you have a $150,000 mortgage with a $120,000 balance. You may be able to refinance that mortgage for $175,000, giving you $55,000 in cash to use as you see fit.
Before you pursue a cash-out refinance, here are seven important considerations to keep in mind.
1. You’ll Need to Qualify for the Loan
When you apply for a cash-out refinance, the lender will subject you to the same approval process as when you originally obtained your mortgage. This means you’ll need to provide documentation of your employment, income, debts, and assets, and you’ll likely need to undergo a credit check.
2. You May Need to Pay Mortgage Insurance
If you put less than 20 percent down on your original mortgage, you’re probably paying mortgage insurance. When you refinance, you may need to pay mortgage insurance again if your new loan balance exceeds 80 percent of your home’s value. Mortgage insurance protects the lender in case you default on your loan, so it’s something you’ll want to factor into your costs.
3. Your Mortgage Rate May Increase
When you refinance, you may be able to choose between a fixed-rate and an adjustable-rate loan. An adjustable-rate loan has a lower interest rate than a fixed-rate loan, but that rate is only fixed for a certain period of time – usually five, seven, or 10 years. After that, your rate will adjust annually, and it could adjust up or down, depending on market conditions.
A fixed-rate loan has a higher interest rate than an adjustable-rate loan, but that rate is fixed for the life of the loan. This makes it easier to budget for your monthly mortgage payment because you’ll know exactly how much it will be every month for the next 15, 20, or 30 years.
4. Your Mortgage Term May Increase
When you refinance, you may be able to choose a different mortgage term. A shorter term will have higher monthly payments but you’ll pay less interest over the life of the loan. A longer term will have lower monthly payments but you’ll pay more interest over the life of the loan.
5. You May Have to Pay Closing Costs
When you refinance, you may have to pay closing costs. These are the fees charged by the lender for processing your loan. They can include fees for appraisal, Origination, and title insurance, among others. Closing costs can add up, so be sure to factor them into your costs when you’re considering a cash-out refinance.
6. You Need to Have Equity in Your Home
In order to qualify for a cash-out refinance, you need to have equity in your home. Equity is the difference between your home’s market value and the balance of your mortgage. So, if your home is worth $200,000 and you have a $150,000 mortgage, you have $50,000 in equity.
7. You Need to Use the Money for a Qualified Purpose
The IRS has strict rules about how you can use the money from a cash-out refinance. You can use it for home improvement projects, investment properties, or education expenses, but you can’t use it for anything else. Be sure to ask your lender about qualified purposes before you proceed with a cash-out refinance.
A cash-out refinance can be a great way to access the equity in your home and use it for other purposes. But there are some things you need to know before you apply. Be sure to consider these seven things before you proceed.