Is a Cash-Out Refinance Right For You?

Homeowners looking to refinance their mortgage loans are generally hoping for one of two benefits: a lower interest rate and lower monthly payments, or a large sum of cash in-hand. If an influx of spendable dollars is what you most need, a cash-out refinance may be the optimal tool for you.

In essence, a cash-out refi allows you to tap into the equity you’ve painstakingly built in your home. Your mortgage loan will be refinanced to add the amount of cash you’d like to “withdraw” so the balance and monthly payments will be higher, but you’ll have an immediate influx of money available to make home improvements, pay medical bills or erase a large credit card debt, for example. This can be a useful option but, like any loan, a cash-out refinance has both pros and cons. Read on to learn if this may be the right tool for you:

Pros

A debt consolidation tool. If a consumer uses a cash-out refinance to pay off high-interest debts like credit cards, they are likely to save thousands of dollars in debt-related interest payments.

A lower interest rate. Like most any refinance, the new mortgage loan is likely to come with a lower interest rate, even if the balance is larger.

A reduction in taxable income. Mortgage interest payments are tax deductible, so a larger mortgage balance means more interest paid – and more deductions come tax time.

Cons

Added PMI. If the cash-out amount is for more than 80 percent of the home’s value, the homeowner will be required to pay Private Mortgage Insurance on top of the monthly loan amount.

More closing costs. Just as with the original home loan, a cash-out consumer will have to pay closing costs on the new mortgage, which could run from $6,000-$10,000 in many markets.

Greater foreclosure risk. A higher loan balance means higher monthly payments, which lead to an increased risk of the home owner being unable to pay the lender.

Image via Flickr/johnquintana