What Is a Cash Out Refinance And What are The Benefits Of a Cash Out Refinance?

Published:
August 24, 2021
Last updated:
November 9, 2021
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A cash-out refinance is a form of mortgage refinancing where the first mortgage is paid off, and a new mortgage is established. For many homeowners, this is an advantageous move. This article will go over what a cash-out refi loan is, how it works, and why it is beneficial for borrowers.

In general, mortgage refinancing has a wealth of benefits, including a decrease in mortgage payments, a possible lower interest rate, better loan terms, and of course, the opportunity for a cash payout when you need it most—just to name a few. However, many homeowners are often looking to reduce one of their largest monthly expenses and have extra money on hand when it comes to a cash-out refinance.

The good news here is that opting for a cash-out refinance affords borrowers all of the benefits of a standard refinancing, such as lower interest rates and other useful modifications. Clearly, this is in addition to getting the lump sum cash payout which borrowers use for a variety of reasons.

The most common ways homeowners use this money is to pay down other high-rate debt, fund large purchases, pay for college, cover the cost of home repairs, and finance home renovation projects or home improvements.

That said, these are not the only benefits of this particular refinancing option. But before going over the additional advantages, it is important to know exactly what a cash-out refinance loan is and how it works.

What Is A Cash-Out Refinance?

A cash-out refinance works by basically replacing your existing mortgage with a new mortgage that allows for some of the equity in your home to be converted into a cash payout. The new mortgage or loan is oftentimes higher than your previous outstanding loan balance.

But it is well worth it because it allows you to take advantage of the equity you have built up in your home by withdrawing the difference between the two mortgages or home loans in cash.

How Does A Cash-Out Refinance Work?

Typically, when you opt to refinance your mortgage, you are basically replacing your existing loan with a new one for the same amount at a lower interest rate, a shorter loan term, or sometimes both.

Yet, with cash-out refinancing, you are withdrawing a portion of your home’s equity in a lump sum through your first mortgage instead of through a second mortgage. Though this particular refinancing option is similar in that respect to a home equity loan or equity lines of credit, it is not the same thing.

After said refinance, your home’s equity will still be 20% or more when it is all said and done. However, it is worth noting that the required percentage does vary depending on the lender, bank, or financial institution.

That said, if you do not have enough equity, that does not necessarily preclude you from a cash-out refinance. In fact, you can access as much cash or the necessary funds you need at an affordable rate, your lender may just require you to pay private mortgage insurance (PMI). With that said it is generally not advisable to do a cash-out refinance unless you maintain at least 20% equity in your home.

How Does A Cash-Out Refinance Compare To A Home Equity Loan Or Home Equity Line Of Credit (HELOC)?

The major difference between these options is that unlike a cash-out refinance,  a home equity loan lets you get cash with a fixed interest rate and, in many ways, is like a second mortgage. A HELOC or a line of credit based on the equity in your home, on the other hand, is actually a second mortgage (in addition to your existing mortgage loan) that requires an additional monthly payment.

With home equity lines or a HELOC, you can typically borrow as much as you want during the draw period and then pay back everything, plus interest, during the repayment period.

As previously mentioned, a cash-out refinance replaces your existing mortgage with a new loan for more money. With this option, the difference between the amount you owe and the amount you borrow is your cash out.

And though rates for cash-out refinancing are slightly higher than for rate and term refinancing,  home equity loans or lines of credit more often than not will come with an even higher interest rate.

What Are The Benefits Associated With A Cash-Out Refinance?

There are several benefits of a cash-out refinance, some of which have already been discussed. Nevertheless, for most homeowners, a cash-out refinance means they have extra money for the important things, and the benefits are twofold:

  • You can borrow a lot of money at lower interest rates
  • It may be the most affordable way to borrow money than any other type of long-term borrowing (credit cards, personal loans, and so on)
  • You receive the difference between the two home loans in tax-free cash
  • Your mortgage interest payments may be tax-deductible in some cases
  • You may be able to secure a lower mortgage rate on your new mortgage or loan
  • You are able to use the cash however you want including, for home improvement projects, or to consolidate debt to improve your credit score, or simply to pay down debt (student loans, personal loans, high-interest rate credit cards, etc.)
  • It could help you eliminate personal debt, pay for college, help you reach your financial goals, or provide you as much cash as you need to make your home nicer
  • Any repairs and home improvements made via a cash-out refi could also increase your home’s value

Are There Any Notable Disadvantages For A Cash-Out Refinance?

Of course, just like anything else, a cash-out refi loan is not without a few disadvantages. For instance, this particular refinancing option may increase your monthly payment because you still owe more overall on your mortgage or new loan. Another drawback may be that it will take you a little longer to pay off your home loan, which may mean you end up paying more in interest over time.

Plus, you can expect to pay closing costs. Typically, most closing costs for a mortgage refinance loans range from 1% to 3%, depending on the loan amount. Note cash-out refinances just like a regular rate and term refinance have no closing cost options available for borrowers with good credit

Other potential financial concerns with this specific loan type are actually minor. For instance, even though a cash-out refi loan can affect your credit score, any slight drop in your existing score is only temporary. So, there is no need to worry.

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When Is A Cash-Out Refinance A Good Option?

Overall, cash-out refinancing is a good option for homeowners and their financial needs. This is especially true if they are looking for an affordable way to borrow money and access additional funds to increase their home’s value.

That said, if you would like more information about refinancing your mortgage, cash-out refi loans, or any costs associated with any of the above-mentioned home loan options, then do not hesitate to contact a local mortgage expert or lender for further financial/home loan assistance.

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Ready To Apply For A Cash-Out Refinance?

Do you have questions about cash-out refis, your current mortgage, home loans, or simply need assistance navigating the current real estate market? If so, Sammamish Mortgage can help. We are a local mortgage company from Bellevue, Washington, serving the entire state, as well as Oregon, Idaho, and Colorado. We offer many mortgage programs, products, and services to buyers all over the Pacific Northwest and have been in the business of doing so since 1992. Contact us today with any questions you have about mortgages.

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