A cash-out refinance could allow you to tap into your home equity by taking out a new mortgage for a larger amount than the balance owed on your current loan. You could use the difference in any way you wanted. A cash-out refinance can be a useful and appropriate tool in some cases, but homeowners who use it for the wrong reasons or who don’t consider all the potential costs can get into trouble.
When to Use a Cash-Out Refinance and When to Find Another Source of Funds
As a general rule, it’s a good idea to use a cash-out refinance for something that will increase your home equity or improve your overall financial circumstances. You shouldn’t use it for short-term goals, such as buying a car or going on vacation.
Home improvements can be a good bet, provided you make upgrades that will increase your home’s value and appeal to potential buyers in the future. Making home improvements that your family liked but that other people wouldn’t value would not be a smart way to use money from a cash-out refinance.
High-interest rates on credit cards can make it difficult to pay off balances. A cash-out refinance at a lower rate could help you pay off your credit cards in one fell swoop, but it could create new risks. If you got behind on your mortgage payments, you could lose your home in foreclosure. You might also be tempted to rack up new credit card debt and you could wind up worse off financially than you were when you started.
Using a cash-out refinance to further your education could be a good idea. You could get a promotion or find a more lucrative job in another field, which could improve your ability to pay your mortgage and other expenses.
If you used money from a cash-out refinance to start a business, it could pay off, or the business could fail, you could be unable to repay the mortgage and you could lose your house in foreclosure.
Consider Costs and Other Options
With a cash-out refinance, you would have to pay closing costs either up front or rolled into the new loan balance. You could also pay more in interest overall than you would have if you had just stuck with your original mortgage. At the beginning of a loan repayment period, a large portion of each payment goes to interest. If you started over with a new loan, most of your payments for the first several years would go toward interest.
Depending on your objective, you might want to consider a home equity loan or line of credit, or a personal, business or student loan. Compare the terms and costs of each to choose the best source of funds for your goal and circumstances.
