30-year fixed-rate mortgages have held steady at record lows since the coronavirus outbreak. With rates around 2.80%, it’s an ideal time for homeowners looking to update their house or pay down credit card debt to talk to their lender about a cash-out refinance.
Cash-out refinances are when homeowners take a second mortgage and use the equity as cash. Sometimes, homeowners can get approval for a second mortgage that’s as much as 80% of what their home is worth.
“With rates that can be considered the lowest in recent history, tapping into your home’s equity can be a great option for finally making that needed home improvement project or paying for another venture,” Michael Hamelburger, CEO of the Bottom Line Group, told Cashay.
If you are interested in leveraging these historic rates and your home’s equity, this can be an excellent strategy. Cashay explains what you should know about cash-out refinances.
How Do Cash-Out Refinances Work?
When the lender approves you for a cash-out refinance, the second mortgage you take out is bigger than your first. The amount of money you get is based on the difference between the two loans.
As an example, say you own a home valued at $500,000. Since you still owe $300,000 on your mortgage, you only own $200,000 in equity. Suppose you need $15,000 for a renovation. When you secure a cash-out refinance, the lender gives you a $315,000 loan, which you then use to repay the $300,000 on the first mortgage. You can then use the remaining $15,000 for your project.
Cash-out refinances have stricter qualifying criteria compared to regular mortgages. Consequently, your credit score will need to be in excellent shape, or you have to have owned your home for a year or more. Another thing to consider is that getting a cash-out refinance can make paying off your home take even longer.
Moreover, some lenders have tightened eligibility restrictions further since unemployment continues to stay at elevated levels. These limitations can make it even harder for homeowners to get approved for a second loan — or even a credit card.
When To Get A Cash-Out Refinance
Although the liquidity of Americans’ home equity has reached an all-time level, only homeowners looking to fund a home improvement project or eliminating debt should consider cash-out refinances.
“The reasons you could take out a cash-out refinance would be a planned capital improvement on your house,” Bill Brancaccio, Rightirement Wealth Partners cofounder, told Cashay. “This would allow the interest to remain tax-deductible.”
Cash-out refinances should also only be taken by those facing high-interest credit card payments. According to the Federal Reserve’s latest household debt report, the country’s collective credit card debt is about $890 billion. Considering that many credit cards levy a 16.04% interest rate, debt consolidation could help many people.
“Let’s say you have a lot of equity in your home and your rate is 5%, and, for one reason or another, you have a credit card at 18% interest with a large balance,” Brancaccio continued. “By rolling that debt you planned on paying into the mortgage, you can save a lot in interest and start over.”
When Homeowners Should Not Get A Cash-Out Refinance
Brancaccio and other experts caution against leveraging home equity for vehicles, college tuition, and other things that can be paid for through methods with better interest rates.
“Don’t do a cash-out refinance to buy a new car as auto lenders are already offering really low-interest rates, and with closing costs this would make this a poor decision,” Brancaccio warned. “Taking money that was already interest-free to add interest to it is a complete gamble.”
In the same vein, parents should not use a cash-out refinance to finance their child’s college fund, as federal interest rates are at historically low levels, as Leslie Beck, the owner of Compass Wealth Management, explained.
“I’m not a big fan of using a cash-out refinance for college education [since] the interest rate on federal student loans for year 2020-2021 is only 2.75%, which is probably lower than the rate you can get for a cashout,” she told Cashay. “You are putting your home at risk for something that can be funded in many other ways.”
- Singh, Dhara. “Near Record Low Mortgage Rates: Should You Cash out and Refinance?” Cashay, Cashay, 22 Oct. 2020, www.cashay.com/near-record-low-mortgage-rates-should-you-cash-out-and-refinance-192622985.html.