Pros and Cons of a Cash-Out Refinance

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Important points

Benefits of cash-out refinancing include potentially accessing funds at a lower interest rate and itemized tax deductions.
The downside is that cash-out refinancing increases your debt burden and depletes your equity. It is also possible that your mortgage payments will take longer.
If you don’t want to replace your entire mortgage with a new loan, you can also consider taking out some of your equity with a home equity loan or home equity line of credit (HELOC).

A cash-out refinance allows you to convert some of your home equity into money that can be used for other expenses or financial goals. Some homeowners use the funds to consolidate debt, finance home improvements, or pay for higher education costs. Some people use the money to start a business, invest in rental property, or make other big purchases. No matter what you want to accomplish with your home equity, check out the pros and cons of cash-out refinancing before you start comparing interest rates.

What is a cash-out refinance?

A cash-out refinance replaces your existing mortgage with a new, higher-priced loan. This new loan will pay off your original mortgage and provide you with additional cash that you can use for any purpose. The cash comes from the equity in your home.

Many cash-out refinance lenders allow you to access up to 80 or 85 percent of the home’s value. However, this amount may vary depending on your creditworthiness, type of property, and current mortgage. Lenders generally require you to maintain at least 15 to 20 percent equity in your home after a cash-out refinance (there are exceptions). This means that if you recently purchased a home with a low down payment, you may not qualify for this type of refinance.

Advantages and disadvantages of cash-out refinancing

As with any financial decision, cash-out refinancing has advantages and disadvantages to consider.

Cash-out refinance professional

Heavy access: The biggest benefit of a cash-out refinance is that it unlocks the home equity you already own, giving you the money you need.
Lower interest rate: Cash-out refinances may have lower interest rates than credit cards or personal loans.
Predictable payments: Even if you refinance to a new fixed rate loan, your monthly principal and interest payments will remain the same. This is not the case for home equity lines of credit (HELOCs), which generally have variable interest rates.
Possible tax deductions: When you file your taxes, you can deduct the interest you pay on the cash you withdraw, as long as you use the funds for qualified home improvements.
Possibility to improve your credit score: Consolidating high-interest debt with a cash-out refi can improve your credit score.

Disadvantages of cash-out refinancing

I owe more: Since you will be taking out a larger loan, your overall debt burden will also increase. No matter how close you are to paying off your original mortgage, cashing out will increase your debt level.
You may push debt into the future: If you’re taking a cash advance to pay off high-interest debt, pause for a moment. Check to see if you’ve addressed the spending issues that caused you to accumulate debt in the first place. Otherwise, you could end up in a debt spiral.
Closing costs: Just like you paid closing costs on your original mortgage, you’ll pay similar costs when refinancing. (Good news: Refinance fees are not as expensive as the closing costs of buying a home.)
Foreclosure risk: With a cash advance refinance, your home is used as collateral, so if you can’t repay the loan, you could lose your home.

Should you get a cash-out refinance?

A cash-out refinance is ideal if you qualify for a higher interest rate than you currently have and plan to use the money to improve your finances or assets. This includes upgrading your home to increase its value or consolidating high-interest debt to create more space in your budget.

However, if you can’t get a lower interest rate, a cash-out refinance may not be your best bet, especially if you’re refinancing to a new 30-year loan.

Additionally, if you plan to sell your home in the short term, it may not make sense to do a cash-out refinance. The larger balance must be paid off at closing.

Cash-out refinancing makes sense in the following situations:

Lower interest rate: When mortgage interest rates can be lowered
Improving your credit score: If you can improve your credit score by using your income to pay off or consolidate your debts.
Tax credit: If you are planning a home renovation that will improve your property. This may qualify you for a federal tax deduction.
More competitive borrowing costs: When borrowing costs are lower than other types of loans, such as home loans or personal loans

Alternatives to cash-out refinance

A cash-out refinance may not be right for you. If so, there are other options that allow you to borrow against the equity in your home, including:

home equity loan: A home equity loan offers a lump sum payment similar to a cash-out refinance. Repay the funds in installments. They typically pay back fixed interest rates that are lower than many other types of consumer finance options.
HELOC: A home equity line of credit (HELOC) is a revolving line of credit that works similar to a credit card. With a HELOC, you can borrow what you need, pay back what you borrowed, and then borrow again. A HELOC has a specific withdrawal period during which you can continue to borrow funds as needed. At the end of the drawing period, the remaining balance will be repaid in installments.

Both options are often faster and cheaper to obtain than a cash-out refi. However, since your home is used as collateral, your interest rate may be higher than refinancing.

What are the steps to getting a cash-out refinance?

The process of obtaining a cash-out refinance is very similar to obtaining a first mortgage. You’ll need to submit financial documents to prove your ability to repay the loan, and you’ll undergo another property appraisal to help the lender assess fair market value. Here’s an overview of what to expect:

Calculate capital: Start by calculating your home’s equity. This will help you understand how much money you can cash out.
Organize your financial records. Be prepared to provide documentation regarding your income, assets, and debts. You will also need to provide information about your existing mortgage and property. If you have recently had an appraisal, be prepared to provide evidence of that as well.
ShopLender offers: Compare at least three mortgage lenders and their interest rates, fees, and terms. The best rates are typically offered to customers with excellent credit, or at least a 740 credit score.
Apply: Next, apply for a cash-out refinance. Once the appraiser has determined the value of your home, the lender can let you know how much you can get with a cash-out refinance.
Close the loan: If approved, finalize loan terms and sign closing documents. You will then receive cash from the difference between your new large loan and your old mortgage balance, minus any associated closing costs.
think: Cash-out refinances have a three-day cancellation period during which you can decide to cancel the entire loan. As long as you are confident in your decision, you can receive your cash after the 3-day period is completed.