Cash Out Refinance Pros and Cons

A cash out refinance lets you tap into the equity you have built into your home. You can use this cash for any expense, but you should know the pros and cons before starting the process. This guide will outline how cash out refinances work, what to consider, and some alternatives. You’ll also discover some of the industry's best cash out refinance companies. 

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What Is Cash Out Refinance?

A cash out refinance is a financial product that lets you tap into your home equity while ending up with a new mortgage. A refinance allows you to stick with one monthly mortgage payment instead of ending up with a second mortgage via a home equity loan or a HELOC.

A cash out refinance starts by replacing your current mortgage with a new mortgage with a higher balance. For example, if you borrow $50,000 worth of home equity and have a $300,000 mortgage, you will have to refinance into a $350,000 mortgage.

Your interest rate will differ, and you can opt for the same term length or modify the number of years on the loan. Converting a mortgage from a 10-year to a 15-year term can result in lower monthly payments even if you borrow equity from your home. After the cash out refinance is finalized, you can access the extra cash in your bank account. In this case, it’s an extra $50,000.

You’ll have to compare various cash out refinance lenders to determine which is right for you. Homeowners should assess each lender’s rate, terms, fees, and other factors before deciding.

Cash Out Refinance Pros

A cash out refinance can be very beneficial for some homeowners. Here are some of the advantages to consider.

Access Home Equity as Cash

A cash out refinance lets you tap into home equity for any expense. The sudden windfall can help with vacations, medical bills, home improvements, or other expenses. You can access money during emergencies and preserve your savings account.

Potential for Lower Interest Rate

If your credit score is higher, you might qualify for a lower interest rate. Getting a lower rate will also be easier if the Federal Reserve decides to reverse course and initiate some rate cuts.

Fixed Interest Rate Option

You can get out of a variable-rate mortgage with a cash out refinance. You can also choose a fixed interest rate for your new mortgage. Fixed rates result in consistent monthly payments and more predictability with budgeting. A fixed-rate mortgage will stay the same if the Federal Reserve decides to hike interest rates.

Potential Tax Deductions

You can deduct the funds you receive from a cash out refinance if you use them for home improvements. Homeowners can also deduct mortgage interest payments to reduce their tax bills.

Consolidate High-Interest Debt

You’ll have to pay interest if you borrow money through any loan or line of credit. However, you will likely get a lower rate with a cash out refinance than unsecured debt like credit cards and personal loans. You can use the cash out refinance to repay your high-interest debt so interest doesn’t compound as quickly. 

May Build Credit

It’s possible to build your credit score with a cash out refinance. You can access additional equity and reduce your monthly payments by extending your term. Then, it will be easier to make on-time payments every month. Each of those monthly mortgage payments will improve your credit score.

Cash Out Refinance Cons

While cash out refinances offer several advantages, they also have several setbacks you should consider.

Closing Costs Involved

Cash out refinances have high closing costs, ranging from 2% to 6% of the loan’s balance. You can either pay those closing costs immediately or tack them onto your loan, accumulating more interest.

Risk of Foreclosure if Defaulted

Any mortgage presents the risk of foreclosure if you default. However, a cash out refinance can increase your monthly payments if you do not adjust the term’s length. Higher mortgage payments can increase the risk of falling behind on monthly payments, but you can extend your loan’s term to minimize this risk.

Increased Mortgage Balance

A cash out refinance increases your mortgage balance, translating into higher monthly payments. That higher balance will also continue to accumulate interest, resulting in a less favorable amortization schedule. 

Longer Loan Term

A longer loan term keeps you in debt longer. One of the main advantages of homeownership is that you can eventually become debt-free and have more budget flexibility. A cash out refinance can force you to extend the loan’s duration to preserve your budget, keeping you in debt longer.

Potential Loss of Equity

A cash out refinance results in lost equity that you’ll have to reaccumulate with monthly mortgage payments. A higher equity position allows you to tap into more cash if necessary and get closer to becoming debt-free.

Should You Get a Cash Out Refinance?

Homeowners should assess their financial situation before getting a cash out refinance. These refinances make the most sense if they need the cash or want to reduce their monthly payments. You may also have the opportunity to reduce your interest rate with a cash out refinance, but higher rates from the Fed make this scenario less likely. 

Refinances make less sense if you have the financial means to cover expenses and want to get out of debt sooner. Once you reach that point, removing monthly mortgage payments from your budget will free up much space.

Compare the Best Cash Out Refinance Companies From Benzinga’s Top Lenders

Homeowners can choose from many mortgage lenders to assist with their cash out refinances. Here are some of the top companies to consider.

Alternatives to Cash Out Refinance

While cash out refinances are popular financial products, there are other ways to tap into your home equity. Here are some of the alternatives.

Home Equity Loan

Home equity loans allow you to access equity as a lump sum. You must make fixed monthly payments over a 5 to 30-year term. You must fulfill credit score and income requirements to get a home equity loan. However, these requirements are similar for cash out refinances and HELOCs.

Home Equity Line of Credit (HELOC)

Home equity lines of credit also let you receive a lump sum, but it comes as a revolving credit line with a variable interest rate. Interest payments only start when you borrow against the credit line. You only have to pay interest during the draw period, which can last 10 years. Any remaining balance gets converted into an installment loan after the draw period. The term for this new loan can be as long as 20 years.

Tapping into Your Home Equity

Building home equity will get you out of debt sooner, but some people need to access their equity for home improvements, medical bills, vacations, and other expenses. A cash out refinance is one way to access equity, but assessing your choices and financial situation is important. Comparing your choices can lead to the best outcome and save money as you access home equity.

Frequently Asked Questions