When a Cash-Out Refinance Really Works

By: Sarah Scrafford (Guest Writer)

It’s easy to borrow money today, especially if you own a home and have a decent credit history. Lenders are more than willing to offer you money based on the value of your home. A cash-out refinance involves you taking a loan that’s an amount more than the mortgage on your home – if your mortgage is $80,000 on a house that’s worth $175,000, and you need $20,000 for some reason, you could cash-out refinance for $100,000; your creditor refinances your mortgage and pays you $20,000.

Though this sounds similar to a home equity loan, there are basic differences between the two:

· A cash-out refinance is a replacement of your mortgage while a home equity loan is separate loan borrowed additional to your mortgage. The similarity is that both loans are secured against your home.

· The interest rates for both are different, with cash-out refinances possessing lower interest rates.

· Closing costs associated with the deal are higher for cash-out refinancing than for home equity loans.

· Cash-out refinances get you between 75 to 80 percent of your equity while a home equity loan fetches 85 percent.

Knowing when to settle for a home equity loan and when to go for a cash-out refinance can make a whole lot of difference to your debt situation.

· If the interest rates on your cash-out refinance are higher than your those on your current mortgage, it makes more sense to go for a home equity loan.

· Also, since closing and other associated costs are higher with cash-out refinances, check if you can get all these amounts included in the loan itself. Then compare the cost of interest with a home equity loan before you make your decision.

· If you’re comfortable making repayments on just one loan instead of juggling around many, a cash-out refinance will work for you.

· If you borrow more than 80 percent of your equity in a cash-out refinance, you’re obliged to pay for a private mortgage insurance or shell out a higher interest rate.

· Cash-out refinances are good when interest rates fall and you want to lock in on the new rates rather than continue to pay the higher, old rates.

· They’re also suitable options when you want to spread out your payments over a longer period of time to bring down your monthly dues.

· Both cash-out refinances and home equity loans are tax deductible, so if you’re looking for some money to pay off a debt that’s not tax deductible, either option will do.

· Cash-out refinances hit you where it hurts the most when the real estate market falls and the value of your home drops suddenly and you find yourself in a predicament if you decide to sell.

· Check around to see if a home equity line of credit (HELOC) loan will work better than a cash-out refinance - HELOCs are advantageous because although you borrow a lump sum of money, you pay interest only on what you use. Also, you can access the money like you would your bank account, drawing what you want at your convenience. A HELOC does not charge interest if you repay what you withdraw before the grace period, similar to running up charges on your credit card.

· A cash-out refinance is good when the extra money is spent on an asset (or expense) that has a long-term value or an equally long life as the loan. Improvements to your home or the purchase of a second home are perfect uses for cash-out refinance money.

Cash-out refinance or home equity loan – there’s a common thread that binds the two, the fact that you could lose the roof over your head if you’re not careful about your repayments. Use both loans wisely since they’re secured with your most valuable financial asset - your home.

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This article is contributed by Sarah Scrafford, who regularly writes on the topic of Best business practices. She invites your questions and writing job opportunities at her personal email address: sarah.scrafford25@gmail.com.