Are you considering a cash out refinance for your next home loan? If you want to borrow against your home equity and refinance the existing loan balance your new mortgage will include what you already owe plus the cash out amount. This type of transaction is known as a cash out refinance. Instead of lowering your payment with today’s low refinance rates your loan size and payment amount will go up. Here’s what you need to know about cash our refinance loans to avoid paying unnecessary fees and markup.
Cash Out Refinance Basics
There are three ways to get cash out of your home’s equity. You can take out a Home Equity Line of Credit (HELOC) in addition to your existing home loan, take out a 2nd loan or use a cash out refinance to access your home’s equity.
Here’s an example to illustrate how this type of transaction works. Suppose you’re interest in taking out a $100,000 to make repairs or remodel your home. Your home is worth $450,000 and has a mortgage balance of $200,000. In this example you have $250,000 equity in your home, enough to borrow $100,000 and keep your loan-to-value ratio well under 80%.
In this example a Home Equity Line of Credit (HELOC) isn’t the best option because of the amount you’re borrowing. HELOCs are best suited for pay as you go borrowing with lower amounts, leaving you the cash out refinance and 2nd mortgage options. (HELOCs also come with higher interest rates and you’ll have two payments to make every month)
2nd Mortgage loans come with lower interest rates than HELOC; however, the main disadvantage is the same as with HELOCs, you’ll have 2 payments to make every month.
The most practice option for most homeowners in this scenario is the cash out refinance. You’ll be able to refinance your existing $200,000 and take out $100,000 of your equity, leaving you with a $300,000 mortgage balance. The advantage of this type of cash out refinance transaction is that you’re left with one home loan and one payment. You have the option of changing your lender to get the most competitive rates and fees on the new mortgage.
In most cases the cash out refinance is the most affordable option as interest rates for this type of transaction are generally lower than 2nd Mortgage loans and HELOCs. Is cash out refinancing right for everyone? Well, no… When the housing bubble burst many homeowners learned a hard lesson not to treat their homes like a piggybank and are still underwater as a result. The danger of any kind of cash out refinance or home equity loan is that you’ll end up owing more that your home is worth if home values continue to decline.
Common Reasons for Cash Out Refinancing
So why do people elect for cash out refinancing? The most common reasons include home improvements, paying college tuition, consolidate debts, pay for emergencies and some for frivolous reasons like taking vacations. The point is that it’s your money and you can use it for whatever you like.
The interest rates for cash out refinancing are much lower than credit cards so consolidating credit card debt is one of the most popular choices. Paying for home improvements is another common use for cash out refinancing as the improvements increase the value of your home.
With any mortgage refinance you’ll want to pay close attention to the fees you’re paying at closing. Because the cash out refinance results in a higher monthly payment it’s not going to be possible to recoup your out-of-pocket expenses paid at closing. The more you pay the less benefit you’ll be getting from the cash you’re pulling out of equity. This includes overpaying the loan origination fee or paying for unnecessary discount points.
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You can learn more about getting the best deal on your cash our refinance while avoiding lender junk fees by checking out my free Underground Mortgage Videos.
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