31 Jul Cash out Refinancing: How it works and when to do it
Finding ways to leverage your home’s equity and achieve your financial goals is any homeowner’s dream. Cash-out refinancing is among the creative ways to meet your changing personal financial needs. This process allows homeowners to tap into their home’s equity and use their funds for various purposes while paying their mortgage.
Refinancing has many benefits for homeowners looking to take advantage of their home’s equity–however, like any financial decision, cash-out refinancing should be approached cautiously and with a thorough understanding of the process.
This article will help you understand cash-out refinancing, how it works, and the benefits and drawbacks of refinancing depending on your financial situation to guarantee that you make the right choice for your financial future.
What is Cash-Out Refinancing?
Cash-out refinancing involves replacing your home’s current mortgage with another, more valuable one. Replacing a home’s mortgage allows homeowners to access the monetary difference between their initial mortgage and current home loan in cash.
The total cash amount in the re-fi process is based on the home’s equity value. When homeowners borrow more than they owe on their mortgage in a lump sum, they can pay off their old home loan and profit from the difference. Funds from the cash-out refinancing process can cover various financial needs, such as home updates and remodeling, tuition payments, high-interest debt payments, and anything else the homeowner might need.
How Does Cash-Out Refinancing Work?
The cash-out re-fi process follows a few basic steps, similar to a traditional loan refinance process. During the refinance process, you tap into a portion of your home equity, withdrawing a lump sum of money added to your new loan balance.
The cash-out refinancing process requires homeowners to pay closing costs like appraisal fees and entails the following steps:
- Lenders vet the homeowner’s income, assets, and credit history to determine whether they can realistically afford the new payment amount.
- Homeowners receive a home appraisal, value acceptance, or hybrid appraisal to determine the home’s overall value.
- Homeowners work with lenders to determine the total borrowing limit. Lenders commonly allow homeowners to borrow up to 80 percent of the property’s value.
- The lender finalizes the total cash-out refinancing amount.
The Pros and Cons of Cash-Out Refinancing
Profiting from a home loan is a valuable opportunity for many homeowners if they are in a secure financial position and willing to take some risks. While cash-out refinancing has numerous advantages, there are some downsides and potential risks to the refinance process to understand before moving forward with your refinancing plan. Below is a breakdown of the primary pros and cons to consider if cash-out refinancing sounds like a viable financial option.
Pros of Cash-Out Refinancing
Potential to Improve Credit
Improving credit is paramount for many homeowners and a significant reason why many choose cash-out refinancing. A cash-out refinance gives homeowners funds that can be used to pay off existing debts, boosting credit scores by lowering the credit utilization ratio.
Lower Your Interest Rate
Cash-out refinancing is often used by homeowners looking to lower their interest rates. This option has a lower interest rate than other home equity financing methods, meaning homeowners won’t have to worry about high-interest rates on larger loans.
Cash-Out Equity Can be Used for Any Purpose
Homeowners aren’t limited to options for using their cash-out refinancing money. This option is ideal for consolidating debt, investing in other properties, conducting home improvement projects, or anything else a homeowner might need additional funds to tackle.
Take Advantage of Tax Deductions
Cash-out refinancing lets homeowners take advantage of tax deductions when they use their funds for home improvement projects that meet IRS requirements. This tax break can make a massive difference when tax season comes around.
Lower Cost-to-Borrow
The cash-out re-fi process also increases the chances that homeowners will have a lower borrowing cost. Because refinancing is typically less expensive than other financing methods, homeowners can borrow large sums without worrying about hefty costs.
Cons of Cash-Out Refinancing
Increased Interest Rate
Though cash-out refinancing can help lower interest rates, it can also increase rates for some homeowners. Cash-out refinances have higher rates than other refinance options, such as rate-reduction refinances. Homeowners with lower credit scores will face high rates they might not be prepared to pay if they choose cash-out refinancing.
Minimum to Qualify
Typically, homeowners need a minimum of 20 percent equity built up to qualify for a cash-out refinancing home loan option, which isn’t suitable for every homeowner.
Higher Monthly Mortgage Payment
A higher loan amount typically means higher monthly mortgage payments for the duration of ownership. Homeowners not prepared for this higher amount won’t benefit from cash-out refinancing.
PMI Payments
Cash-out refinancing sometimes requires homeowners to pay for private mortgage insurance (PMI) if they withdraw more than 80 percent of the equity threshold on their home loan. Though some lenders allow up to 90 percent of a home’s equity to be withdrawn, borrowing at this rate is risky, and PMI adds to the overall cost.
Increased Risk of Losing Your Home
If a homeowner fails to repay a cash-out refinance loan, they have a greater chance of losing their home to foreclosure. Homeowners who take out more than they need to borrow often put themselves in risky situations where they cannot afford to fulfill repayment obligations.
Long-Term Payments
A larger loan means homeowners might have to make payments for the foreseeable future, prolonging the debt repayment process.
Refinance Your Home With First Vision Mortgage
Cash-out refinancing is a delicate process that requires careful consideration and guidance from an experienced mortgage advisor to avoid the pitfalls many homeowners fall into. The mortgage lenders at First Vision Mortgage can help you make wise financial decisions that benefit you in the long term to secure a prosperous financial future.
First Vision Mortgage offers a wide mix of mortgage and refinance services for homeowners across Middle Tennessee. Our team will guide you through the cash-out refinancing process to ensure that you make the right decisions and put your financial well-being first. Contact First Vision Mortgage today to discuss your next steps with a mortgage advisor.