Cash-Out Refinance: Pay Down Your Debts, Even in This Market
A cash-out refinance is a mortgage that allows you to borrow money against the equity in your home. The amount you can borrow is typically limited to 80% of your home’s appraised value. You can use the money for any purpose, such as debt consolidation, home improvements, or college tuition.
In a rising interest rate environment, a cash-out refinance can be a good way to lock in an interest rate on your mortgage. This can save you money on your monthly payments and over the life of the loan.
The Benefits of Paying Off High-Interest Debts
There are many benefits to paying off high-interest debts. First, it can free up cash flow that you can use for other purposes, such as saving for retirement or investing. Second, it can help you improve your credit score. Third, it can reduce your overall debt burden, which can make you feel more financially secure.
Credit card debt
According to the American Bankers Association, most people with an active credit card account don’t always pay their bills in full. A November 2022 LendingTree survey found that just 35% of cardholders say they always pay their credit card balance in full every month, while 65% say they carry a balance at least some of the time. Nearly half (46%) of those cardholders who have card debt say it would take them at least a year to pay it off.
Overall, the national average card debt among cardholders with unpaid balances in December 2022 was $7,279. That includes debt from bank cards and retail credit cards. For cards accruing interest, the average in the second quarter of 2023 was 22.16%.
On average over the life of a 5-year payoff the average credit card balance would accrue a whopping 62% in interest costs. That’s $4,510.90/$7,279.00 or a whopping 61.9%.
Auto loansOn average, drivers are spending over $700 and $500 each month for new and used vehicles, respectively, according to Experian’s fourth-quarter automotive finance report.
Here are the average loan costs for new and used automobiles:
On a new vehicle you can expect to pay about 20% in total interest and 29% on a used vehicle.
Student loans
According to the Education Data Initiative, the average monthly student loan payment is an estimated $503 based on previously recorded average payments and median average salaries among college graduates.
- The average borrower takes 20 years to repay their student loan debt.
- The average student loan accrues $27,000 in interest alone over 20 years (at the rounded average interest rate of 6%).
- Up to 42% of the average borrower’s total cost of repayment is generated interest.
Are You Sending Good Money After Bad?
One thing all of these debts have in common is that they are tied to long-term depreciating or non-value assets. In other words your paying thousands in interest for something that in the ultimate has little to no value.
On the other hand, a cash-out refinance is tied to a long-term appreciating asset. According to the National Association of Realtors, the price of existing homes increased by 5.4% annually from 1968 to 2009, on average.
So the idea is that while you will be paying interest on a cash-out refinance, the value of the asset underlying the loan is growing over the long-term. While paying interest on a depreciating asset makes the interest cost all that much more painful.
Let’s Look at Some Potential Tax Benefits
When you take out a cash-out refinance, you borrow money against the equity in your home and receive the money in cash. The IRS does not consider this money to be income, so you do not have to pay taxes on it. However, there are some limitations on how you can use the money without triggering tax implications.
What are the tax implications of using cash-out refinance money for home improvements?
If you use the money from a cash-out refinance to make home improvements, you may be able to deduct the interest you pay on the loan. However, the improvement must be considered a “capital improvement” to qualify for the deduction. A capital improvement is an improvement that adds to the value of your home, prolongs its useful life, or adapts it to new uses.
Some examples of capital improvements include:
- Adding a new room or bathroom
- Remodeling your kitchen or bathroom
- Replacing your roof
- Installing new windows or doors
- Adding a deck or patio
If you use the money from a cash-out refinance to make repairs to your home, you will not be able to deduct the interest you pay on the loan. Repairs are not considered capital improvements because they do not increase the value of your home or prolong its useful life.
What are the tax implications of using cash-out refinance money for other purposes?
If you use the money from a cash-out refinance for any purpose other than home improvements, you will not be able to deduct the interest you pay on the loan. This includes using the money to pay off debt, consolidate debt, or make a down payment on another property.
How do I claim a deduction for the interest I pay on a cash-out refinance?
To claim a deduction for the interest you pay on a cash-out refinance, you must itemize your deductions on your federal income tax return. You can find the interest deduction form, Schedule A, on the IRS website.
When you fill out Schedule A, you will need to enter the amount of interest you paid on your cash-out refinance loan during the year. You will also need to provide the date the loan was originated and the loan amount.
If you have any questions about the tax implications of a cash-out refinance, you should consult with a tax advisor.
A tax advisor can help you determine if you are eligible to claim a deduction for the interest you pay on your cash-out refinance and can help you file your taxes correctly.
Should You Do a Cash-Out Refinance?
A cash-out refinance could make sense if you need money to pay off debt or cover large expenses, such as college tuition. Mortgage rates are often lower than rates for personal or student loans, and mortgage interest may be tax deductible. Additionally, a cash-out refinance is backed by an appreciating asset, which means that in the long term, you could save even more money.
The value of your home is likely to appreciate over time. This means that the equity in your home will also increase. If you ever sell your home, you will be able to repay the cash-out refinance loan with the proceeds from the sale.
Of course, there are some risks associated with a cash-out refinance. You will need to make sure that you can afford the higher monthly payments. You should also be aware of the closing costs associated with a refinance.
If you are considering a cash-out refinance, it is important to talk to a financial advisor to get personalized advice. They can help you determine if a cash-out refinance is right for you and help you find the best loan terms.
Call Embrace Home Loans® today at 800-333-3004 to speak with one of our knowledgeable loan officers and learn more about your refinance options. Or, fill out our easy, convenient online application, and one of our specialists will contact you as soon as possible. You can also try out our Mortgage Calculator.
