A cash-out refinance is a way
to make some money off the equity you’ve built in your home. It replaces your
original mortgage with a new loan for more than what you currently owe. In a
way, you are reselling a portion of your house that you now own (the equity)
back to a lender for cash. You then restart the process of paying this
back.
Why would someone go this route instead of taking out a personal
loan? There is a much lower rate of interest on the money you’ll get in a
cash-out refinance, and, if you are using it for home improvements, you can
deduct the full interest amount on your taxes.
This being a refinance,
you should also be looking for a better interest rate than you have with your
current mortgage, even though you’ll probably be extending the period of your
loan.
Not a Home Equity Loan
Home equity loans, commonly known as “
second
mortgages,” are separate loans from your original mortgage, essentially
liquidating some or all of the equity in your home. Your original mortgage stays
the same, and now you’ve added a second loan on top of it.
A cash-out
refinance, on the other hand, replaces your existing mortgage with a new one. If
the market has better interest rates now than when you got your initial
mortgage, you’ll probably want to kill two birds with one stone and do a
cash-out refinance. If, however, you still want to borrow against your equity,
but the new interest rates will negatively affect your current mortgage, you
might take out a home equity loan separate from your mortgage.
Some Points to Consider
- A new mortgage could mean that you have to pay private
mortgage insurance (PMI). If you are borrowing more than 80% of your home’s
value, the lender will want some protection in case you default. This may or may
not make the difference between a second mortgage or a cash-out
refinance.
- Whatever you take this loan out for, you’ll be paying it off for a long
time. Weigh your need/desire for the cash against the fact that it might not be
taken care of for 15 to 30 years.
- You might not have to pay closing costs on a home equity
loan.
- If you are quite far into paying off your mortgage, refinancing is probably
not the best option.
So, the equity you’ve built up in your home can
be used right now; it's not just a representation of how far you’ve come in
paying off your loan. It is important to be careful, however. Without doing the
proper research, you could end up a lot more in debt than you were before and
with not much to show for it.