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Pros and Cons of a Cash-Out Refinance


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TERMINOLOGY

A cash out refinance is a popular way to consolidate debt or to get cash for home repairs. A house is usually a borrowers biggest asset, and it can be used to borrow against in order to get cash you need. There are pros and cons of borrowing equity from your home, and every homeowner needs to understand the benefits and the risks of doing a cash out refinance.

Pros

A cash out refinance has advantages. If you need to borrow money, usually a mortgage is going to give you the best interest rate. For example, if you are considering a cash out refinance in order to make some home repairs, it is going to be cheaper to refinance than to put the repairs on a credit card with a high interest rate.

Home loans also have a big tax advantage. If you refinance or take out a home equity loan, the interest you pay on these loans is tax deductible. Some of the closing costs are also tax deductible. The biggest advantage to a cash out refinance is the cash reserves you will receive. You can use the money any way you wish. It is common to cash out in order to pay off debt, make repairs around the house or pay for college.

Cons

The biggest disadvantage is that you are usually increasing your mortgage amount, or extending your mortgage terms, which can be risky. If you were to lose your job or become injured, your mortgage may be more than you can afford and you could ultimately end up in a foreclosure. Also, by having a higher mortgage you could end up owing more on your loan than what the value of your home is, should property values fall. If your loan becomes too high, you won't be able to sell the home if you need to. Also, you would be paying more on the home than it is worth.

A cash out refinance also will change the terms of your current mortgage. If you have been paying for your home for fifteen years, and only have fifteen years left, a refinance will create a new thirty year loan, extending the length of time you have to repay. Another disadvantage is the fees involved with the refinance. There are closing costs that are incurred with every home loan, and they will be around 3 to 5 percent of your loan amount. These fees are required to either be paid in cash, or rolled into the mortgage. If rolled into the mortgage, then you will be repaying these fees for the next thirty years. If you are refinancing in order to consolidate debt, a possible problem will be that after the debt is paid and rolled into your new mortgage, you will incur more debt and not have any available equity.