Although a cash-out refinance can offer a number of benefits to a homeowner, this doesn’t necessarily mean that it’s the right decision for everyone who has decided to refinance. The ‘cash-out’ decision means that a homeowner essentially trades in a portion of their home’s equity for cash that can then be used for various purposes. But there are many things to be aware of when considering this refinancing type.
How Cash Out Refinancing Works
Home equity, or the difference between the fair market value of your property and what you owe on your mortgage, is an intangible item. This is because equity isn’t held in a banking institution or by a creditor. However, equity is measurable and can be accessed by the homeowner via a cash-out refinance.
The cash-out refinance process consists of taking out a new mortgage. This new mortgage will have a larger principle than your current loan. Because of this, you receive the difference between your current and your new mortgage in cash.
What a Cash-Out Refinance Can Be Used For
The money from a cash-out refinance can be used to improve cash flow. In refinancing, the homeowner can consolidate any debts. This will allow the homeowner who is on a tight budget to enjoy lower monthly payments, and thus, better cash flow.
Similarly, a cash-out refinance can also help a homeowner to improve their credit score. This can be done by both consolidating their debt into a cash-out refinance, and keeping any existing credit card accounts open. This will result in zero balances being evident following the refinance, which lowers the utilization ratio, which is a percentage of the available credit that a homeowner uses at any one time.
The money from a cash-out refinance can be used to make a large purchase, such as when a home requires significant repairs or renovations. It can also be used for the additional purchase of property, which can increase the amount of leverage a homeowner has.
Negative Uses for the Cash-Out Refinance
Many homeowners will use the money received from a cash-out refinance to purchase luxury items, such as a boat or recreational vehicle. Another way that many use the cash is to make an investment in the stock market. And there are several homeowners who have used the money to take a vacation, as well as purchase items that won’t help their home to increase in value.
Risks of the Cash-Out Option
The reason that a cash-out refinance may not be for everyone is due to the risks it carries. Despite its many benefits, a cash-out refinance will ultimately result in an increased debt load to the homeowner. This can translate into a higher chance of foreclosure should a homeowner’s income change due to illness or job loss.
The economy presents another risk to the homeowner who chooses a cash-out refinance. Although no one can know what will happen in the future, using a home’s equity as a funding source can mean a homeowner is not in a position to sell their home at market value when the time comes. Additionally, it may mean a homeowner ends up paying more each month on their loan.
The Cash-In Option
A cash-in refinance is helping many Americans to reduce their balances as well as pay less interest over time. This option simply involves paying cash toward the principal at closing in order to reduce the loan amount being refinanced. It appears to be quite popular, with 39% of current refinances being of the cash-in variety.
Today’s homeowner appears to be much more mindful of the debt they carry. This is reflected in Freddie Mac figures, which show that most homeowners who refinance their mortgages will either decrease their debt level or remain in the same amount of debt. Today, only sixteen percent of homeowners will increase their debt load by taking out a larger loan.
The most important thing to remember when considering the cash-out refinance options is that it should not represent income. Nor, say the experts should it be considered to be a casual transaction. Instead, homeowner thinking about this option should consider it a strategic move to increase the value of their home.
Citations:
- Freddie Mac Refinance Archives
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Guest author Tony Donovan writes on a variety of topics related to the mortgage industry. He recommends consumers look at a variety of scenarios before selecting a refinance home mortgage option.