Cash out mortgages are no different than conventional loans except that you walk way from closing with a check in hand. The money you borrow comes from your home equity and is added to the outstanding balance of your loan.
Suppose for example you refinance your 8.5% mortgage on a $175,000 balance to a new 6.5% loan. Instead of refinancing the balance of $175,000 you obtain a new mortgage for $200,000 and walk away with $25,000 to spend as you see fit. Sounds like a good deal, right? It can be a good deal; however, there are several things you need to be aware of to avoid making costly mistakes.
One common mistake homeowners make is borrowing too much compared to the appraised value of your home. Mortgage lenders don’t like your mortgage to exceed 80% of your homes value. If you borrow more than this amount the lender could require you to purchase Private Mortgage Insurance (PMI). PMI is expensive and could add hundreds of dollars to your monthly payment. If you borrow more than 80% of your homes value the interest rate you receive will be higher than if you stayed below the 80% threshold.
Mortgage lenders charge more and require Private Mortgage Insurance because the foreclosure rate on cash out mortgages is higher than the default rate on conventional mortgage loans. You can learn more about your cash out mortgage refinancing options, including expensive mistakes like Private Mortgage Insurance that you need to avoid, with our free mortgage video tutorial.