Cash Out Refinancing Pros and Cons

How Cash Out Refinancing Works

Cash out refinancing allows you to refinance your home for more than it is worth and pocket the extra cash at closing. The money that you get back can be used for debt consolidation, college tuition, home improvements, or anything else you wish to spend the money on.

Cash out refinancing is similar to taking out a second mortgage or home equity loan, with a few exceptions. When you get a home equity loan/second mortgage, you end up with two payments- your existing mortgage payment and the new loan payment. When you get a cash out refinance loan, you completely pay off your first mortgage and replace it with a new one.

Sound confusing? Here is an example to explain exactly how cash out refinancing works:

Let's say you owe $70,000 on your home, which is currently valued at $120,000. You refinance your loan for $100,000, pay off your existing $70,000 mortgage loan, and keep the difference of $30,000.

Your new mortgage payments will then be based on the $100,000 amount—the $70,000 that you used to pay off the first mortgage and the $30,000 that you kept to spend as needed.

As you can see in the example shown above, cash out refinancing can supply you with a significant chunk of change. The total amount that you can borrow will depend on how much you owe on you home, the home's value, and the type of lender you choose. Some lenders will allow you to borrow only 80 percent of your home's value, while others will allow you to borrow as much as 125 percent.

If this all sounds too good to be true, it may be because it is. The bad part about cash out refinancing is that you will need to pay back every penny that you borrow. It is a good idea to think on that carefully and evaluate all of the cash out refinancing pros and cons before rushing into anything.

Cash Out Refinancing Pros and Cons

For most people, homes are more than a place to live; they are an investment. This has become very clear given the number of homeowners who have taken advantage of cash out refinancing.

If you are thinking about joining the crowd and borrowing on the equity in your home, there are a few cash out refinancing pros and cons that you will want to consider before signing on the dotted line.

Pros

• Cash out refinancing can provide you with a lump sum of money that can be used however you see fit.
• In most cases, cash out refinancing is easy to qualify for because you already own the home, and more importantly, you probably owe less than it is actually worth.
• There may be significant tax benefits to cash out refinancing if the loan is used to pay off other debt on which the interest is not tax deductible.
• If you can get a lower interest rate than what you pay currently, cash out refinancing can be a win-win situation.
• Interest rates are usually lower on cash out refinance loans than they are on home equity loans.

Cons

• When you take advantage of cash out refinancing, you may be required to pay hundreds, or even thousands, in upfront closing costs.
• Cash out refinancing may not be in your best interest financially if you can't get a lower interest rate.
• If you borrow more than 80 percent of the value of your home, you may be required to pay costly private mortgage insurance.
• If your home loses value, you could find yourself in financial trouble if you ever decide to sell.

In Conclusion

Before choosing to take the plunge, be sure to examine cash out refinancing pros and cons to determine whether it is the best option for your financial situation and home ownership needs.