Tapping the Equity in Your Home for Cash: When a Cash-Out Refinance Might Make Sense
If you own your own home, you may have heard that a cash-out refinance can be a solid option for big expenses. While this is true, not all large expenses are created equal. To that end, we have listed some scenarios where borrowing against the equity in your home might make sense.
Keep reading to learn more about what they are and how a cash-out refinance can help you cover those costs.
What is a cash-out refinance?
At its core, the process behind a cash-out refinance is the same as any other type of refinancing. Put simply, in this scenario, you take out a new home loan and use it to pay off your old one. Typically, the new home loan will have better terms than your existing mortgage.
However, there is one feature that sets a cash-out refinance apart from a rate-and-term refinance. In this case, you’re given the opportunity to borrow more money than you currently owe on your home. When the loan goes through, the difference between what you borrowed and what you owe will be given to you to use however you see fit.
4 times when tapping the equity in your home might make sense
That said, tapping into your home equity is a big deal. It’s generally not recommended to refinance your home loan in order to fund non-essential expenses like a lavish vacation or a new car. Still, there are a few occasions where borrowing against the equity that you’ve built up in your home might make financial sense. In light of that, we have listed four of them for you below:
1. Covering education costs.
There’s no denying that getting a new degree is expensive. Whether you’re hoping to finance your child’s education costs or your own, a cash-out refinance might be a good way to do it. In this case, while interest rates are still historically low, there’s a chance that you may be able to borrow the money you need for school at a much better interest rate than you would receive if you took out a student loan for the same amount.
2. Paying off high-interest debt.
Again, in general, the interest rates you’ll receive for mortgages are typically lower than the rates given for other financial products. For example, as of the time of writing, the most recent figures from the Federal Reserve, show that the average interest rate on a credit card is currently 14.75% and the average rate on a personal loan is 9.46%. In contrast, according to Freddie Mac, the average interest rate on a mortgage is currently just 2.98%.
The caveat here is that it’s also important to look at the cause of the debt. One-time expenses, such as medical debts, are particularly good candidates for a cash-out refinance. While credit card debt can be as well, in that case, it’s important to also take a look at your spending habits. A cash-out refinance will not be of as much benefit if you start accumulating new debt after you’ve paid off the original bills.
3. Financing home renovations.
Home renovations are another excellent reason to do a cash-out refinance. Here, you have the additional benefit of adding value to your home once the projects are completed, which may help to replace some of the equity that you’re borrowing against. To that end, if you’ve been meaning to take on a larger home renovation project such as a bathroom or kitchen remodel, a cash-out refinance may be a smart way to access the money you need.
4. Building your portfolio.
Lastly, if you are a real estate investor, you may be able to leverage the equity in your home to help you to build a bigger real estate portfolio. If you decide to take this route, you would use the excess proceeds from your cash-out refinance as the down payment on another investment property. The key with this maneuver is just to ensure that you don’t stretch yourself too thin and that you’re able to keep up with all of your debt obligations.
The bottom line about leveraging the equity in your home
At the end of the day, if you have a big expense that you need to cover, a cash-out refinance might be a solid option for obtaining the money you need. Particularly while interest rates are historically low, it is one most affordable avenues that a homeowner can take. However, borrowing against your largest asset is still a big decision. With that in mind, it’s always a good idea to talk to a lender about whether or not a cash-out refinance is appropriate for you before getting started.