Turning Home Equity into Cash with a Cash-Out Refinance

Answer

Homeowners often tap into accumulated equity to fund renovations, debt consolidation, or other major expenses. A cash-out refinance replaces your existing mortgage with a larger loan, letting you pocket the difference as tax-free cash (subject to IRS rules).

Here’s how a cash-out refinance works and what to expect:

• Loan Replacement: You pay off your current mortgage by taking out a new loan. Lenders typically allow you to borrow up to 70–80% of your home’s current appraised value, minus your remaining balance.
• Net Proceeds: After closing costs (usually 2–5% of the new loan amount), you receive the remaining funds in a check or electronic deposit.
• Interest Rate: Cash-out refi rates often run 0.25–0.50 percentage points higher than purchase-rate refinances. Shopping multiple lenders can help you secure the best deal.
• Loan Terms: You can choose a similar term (e.g., 30-year fixed) to keep monthly payments predictable, or adjust the term to shorten your payoff horizon—bearing in mind that shorter terms typically carry lower rates but higher monthly payments.

Advantages of a cash-out refinance include:

• Lower Interest Than Credit Lines: Mortgage rates beat many home equity lines of credit (HELOCs) and consumer loans.
• Single Loan Payment: You consolidate debt into one payment, simplifying budgeting.
• Potential Tax Benefits: Interest may be deductible if you use proceeds for home improvements—consult IRS Publication 936.

However, consider these factors:

• Closing Costs: You’ll pay appraisal, title, and origination fees similar to your original refinance (often $2,000–$5,000).
• Longer Repayment: Extending your loan term may increase total interest paid over the life of the loan.
• Risk of Overborrowing: Using your home as collateral means default can lead to foreclosure if you fall behind on payments.

Before proceeding, compare rates from multiple lenders and run a break-even analysis to see how long you must remain in the home to recoup closing costs. It’s advisable to consult a licensed mortgage professional to verify eligibility and tailor terms to your financial goals.