Homeowners today have many options when it comes to turning their home equity into credit and cash. Options include reverse mortgages, home equity lines of credit, and home equity loans (second mortgages). However, a cash out refinance or cash out mortgage is also a very viable option and is gaining in popularity due to its great terms.
What is a Cash Out Mortgage?
In simple terms, a cash out refinance is when you refinance your mortgage for more than you owe. You get the difference to do with what you want. For instance, you owe $250,000 on your $500,000 home and you want a lower interest rate. You also want $30,000 in cash for home improvements or your child’s college education. You refinance your mortgage for $280,000. Typically, you will receive a better interest rate on the $250,000 that you still owe on your home and you receive the remaining $30,000 to do with as you please.
How is a Cash Out Mortgage Different from a Home Equity Loan?
There are several distinct differences between a cash out mortgage and a home equity loan although they look very similar.
• A cash out mortgage replaces a first mortgage; a home equity loan is separate from a first mortgage.
• Cash out mortgages typically have lower interest rates than home equity loans.
• There are usually no closing costs for home equity loans, but there are for cash out mortgages.
What are the Pros of a Cash Out Mortgage?
Cash out mortgages can present some great advantages. You should thoroughly review all terms and potential outcomes in order to determine if a cash out mortgage is right for you. Some of the perks include:
• Potential for lower interest rates. A cash out mortgage will typically offer a lower interest rate making it very attractive to many homeowners.
• Potential boost to your credit score. When you use your cash out mortgage to consolidate your debt it can give you a higher credit score. This occurs because you reduce your credit utilization ratio when you pay off your credit cards in full. This decreases the amount of your available credit that is in use, thus lowering your score.
• Consolidate your debt. A cash out mortgage can give you the money to pay off your credit card debt, particularly high interest cards.
• Tax deductions. The interest on mortgage payments is tax deductible. When you do a cash out mortgage, you create a reduction in your taxable income which lends a larger tax refund.
What are the Cons of a Cash Out Mortgage?
As with any financial decision, there are some downsides to cash out mortgages.
• New mortgage terms. Any new mortgage will not have the same terms as the original loan. Before you accept the new terms, make sure you thoroughly review them, especially your new interest rate and fees.
• You may be required to get private mortgage insurance. You will have to get private mortgage insurance if you borrow in excess of 80 percent of the value of your home.
• Increased risk of foreclosure. Any type of mortgage uses your home as collateral. This means that if you can’t make the payments you could lose it.
• Closing costs. Paying closing costs is standard for a cash out mortgage. Closing costs typically range from 3 percent to 6 percent. For some buyers this is a deal breaker so make sure that what you will save is worth the cost.
A cash out mortgage may be a good option for you if you are able to get a good interest rate and need some extra cash. The key is to use the money in a way that will give you a good return, such as debt consolidation, a college education or home improvement. Using it to purchase a new car or fund a vacation is not a wise financial move