When it comes to refinancing your home, a cash-out refinance loan can be an alluring option—especially if you are looking to make home improvements or consolidate high-interest debt. At Landmark National Bank, our mortgage specialists are here to detail the fundamentals of a cash-out refinance loan. In this guide, we will explain just exactly what a cash-out refinance loan is, as well as its benefits and risks to help you make a more informed decision when choosing a home loan that meets your needs.
What is a cash-out refinance loan?
A cash-out refinance loan (sometimes referred to as a debt consolidation refinance loan) replaces your existing mortgage loan with a new loan that is worth more than what you owe on your home. Then, this extra amount is transferred to you in cash to use on home renovations, debt consolidation, or other major purchases.
Do I qualify for a cash-out refinance loan?
To qualify for a cash-out refinance loan, you must have at least 20% equity in your home, which means a maximum of 80% loan-to-value (LTV) ratio of your home’s current value.
How to Calculate Your LTV and Home Equity Amount
To calculate your LTV, simply take the amount of your existing loan and divide it by the appraised value of your home. For example, if your mortgage balance is $100,000 and your home’s appraised value is $250,000, your LTV would be 40%. This means you would have 60% equity in your home.
It’s important to note that most cash-out refinance loans limit cash-out amounts to 80% of your home’s value. Using our above example, if your home is appraised at $250,000 and your mortgage balance is $100,000, you could borrow 80% of your home’s value and get a cash-out refinance loan for $200,000. This new loan accounts for your existing loan amount while giving you $100,000 for home improvements or to pay off other debts.
The Benefits of a Cash-Out Refinance Loan
Just like other home refinancing options, cash-out refinance loans could give you a lower interest rate than what you received when you originally purchased your home. However, the real benefits of a cash-out refinance loan lie with your ability to receive the difference of your new loan in the form of cash. Many people use this cash difference to do things like:
- Remodel a Property – One of the most common reasons people tap into the equity of their home is to remodel or renovate. For example, a buyer could take a short-term construction loan and then use a cash-out refinance loan on their property’s new, higher value to repay the costs. Additionally, mortgage interest deductions may be available for a cash-out refinance if you use your money to significantly improve your home.
- Pay Off or Consolidate Debt – Using the money from a cash-out refinance loan, you can pay off debt or consolidate debt, especially if you are paying high-interest rates on credit cards or personal loans. Typically, cash-out refi loans provide lower interest rates than other lending products. As an extra bonus, paying off your credit card debt with this type of loan can help boost your credit scores.
- Make a Large Purchase – Many people use cash-out refinance loans to make large purchases, such as paying for college tuition. This type of loan is especially helpful if student loan interest rates are higher than the rate of a new mortgage loan.
The Risks of a Cash-Out Refinance Loan
While a cash-out refinance loan could get you a lower interest rate, this type of loan increases the amount you are borrowing—and this could result in higher monthly mortgage payments or a longer loan term. Additionally, you will likely have to pay closing costs and other associated fees with the new loan. Other major risks of a cash-out refinance loan include:
- Higher Interest Rates – If you are considering a cash-out refinance loan while interest rates are high, it may not be a wise choice to move forward. Higher interest rates could tack on extra costs to your monthly payments, which dramatically increases the amount you pay in the long run.
- Foreclosure – Just like other mortgage loans, taking out a cash-out refinance loan means your home is the collateral for the loan. However, because you are borrowing more than a standard home loan (while possibly increasing your monthly payments), you could be at a higher risk for not making your payments and foreclosing on your property.
- Increasing Debt – While paying off credit card or private loan debt with a cash-out refi could leave you with lower interest rates, it could also put you at risk for going further into debt. Once your credit cards or private loans are paid off, you could be tempted to use these lending products to rack up more debt. This could leave you in a worse place than where you started.
Discover If a Cash-Out Refinance is Right For You with Landmark
Cash-out refinance loans can be a solid option if you’re able to obtain a lower mortgage loan interest rate, consolidate debt at a lower interest rate, or if you plan to put money back into your home with renovations or a remodel. On the flip side, these types of loans can be risky, and they aren’t recommended for doing things like going on luxury vacations or buying a new car.
Want to find out if a cash-out refinance loan is a solid option for your current situation? At Landmark National Bank, our mortgage specialists are standing by to help you find the perfect refinance loan for your needs. Find a lender near you today to learn more!
One comment on “Is a cash-out refinance a good idea? Here’s what you should know.”
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