This is a particular type of refinance made for more money than the current mortgage, designed to leave the borrower with extra cash to use afterward.
To best explain a cash-out refinance, let's turn to a few numbers. Say you bought a house with a $120,000 mortgage, and have paid that mortgage down to $80,000. You decide to refinance, but instead of just refinancing for the remaining mortgage amount, you get a home loan for $95,000 using the extra equity in your home. After closing costs and fees, that leaves you with over $10,000 to use for something extra – maybe you want to pay off some old credit card debt, or pay for a bathroom renovation, or finance new education to improve your employment value. The goal of a cash-out refinance is end up with extra cash that you can use as you see fit.
Pros and ConsPros
-Rewarded for equity. Having paid off your mortgage and built up enough equity, a cash-out refinance allows you to benefit from your hard work – and reward yourself a little.
-Closing costs are taken care of. Sure, it may decrease the amount of total cash that you end up with, but you also don't need to worry about coming up with enough cash to cover closing costs, which can reach thousands of dollars.
-Potential for better terms. As with all refinances, there is the potential to find better terms than your current mortgage, such as a lower interest rate to save you money.Cons
-You have to pay interest on that extra money. While you get extra cash now, you'll have to pay extra interest through the life of the loan.
-Cash-outs are as valuable as what you do with them. There are good and bad investments: Spending your cash-out unwisely is a poor use of this type of mortgage.
-Refinance caveats apply. As with other refinances, there is no guarantee that you can lower payments, get a particular amount of cash, or improve your terms.
What Else Should I Know?
Cash-out refinances are very situation-dependent, depending on your financial life and aspirations: Ideally you want a mortgage that is not too old and not too new, along with a clear plan for using the cash to further your life goals. If you are considering a cash-out option, it's time to look around and ask, "Is this right for us, right now?"