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Cash Out Refinance and 2nd Mortgages
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Overview:
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Cash-out refinance or home equity loan? The debate continues...
Cash-out refinancing can be cheaper and less risky in many situations. If you have equity in
your home and want to borrow at a low rate, a cash-out refinance may be a great way to pay
off debt.
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It's the age old dilemma. Cash-out refinance or home equity loan - which one should you use
to pay off your debt?
First of all, if you need cash you probably want it pretty fast. Technology has made that
extremely possible in this day and age of instant financial transactions and online purchasing.
Second, you have equity in your home because you bought wisely, spent a little bit to update
your "castle" and now it's worth more than you owe. That was smart of you. Good job!
Third, you want to borrow at a low rate and you want the possibility of tax-deductible interest.
Who doesn't, right?
So, you investigate and compare a cash-out refinance against an old-fashioned home equity
loan or line of credit. Without getting into too many specifics here, more often than not, a cash
-out refinance will cost less and make more financial sense (keep in mind, lots of stuff
influences final mortgage numbers so you'll need to have a mortgage professional review your
situation to make absolutely sure).
Why choose a Cash-Out Refinance?
A home equity loan or home equity line of credit are usually second mortgages. In other words,
they are mortgages that you take out on top of the first, or main, mortgage that you have on
your home. This makes them second liens against your property and therefore they are more
risky and expensive for both you and your mortgage company. A cash-out refinance is not a
second loan; it is a new first mortgage.
The purpose is to completely pay off the original mortgage, and borrow a set amount of money
against the remaining equity in your home. It's less risky and cheaper because it's a first
mortgage, not a second. With few exceptions, the rates on cash-out refinances are almost
always lower than home equity loans or home equity lines of credit. There may be more
closings costs with a cash-out refinance, but usually these are made up in the long run with
lower monthly interest payments.
How a Cash-Out Refinance Works
Let's say, for simplicities sake, you have a $100,000 mortgage balance on a home worth
$150,000. Your daughter wants to go to college to pursue her education dreams and you
decide to borrow $25,000 to help pay expenses. With a cash-out refinance, you would simply
get a cash-out refinance mortgage on your home for $125,000 (well under the appraised price
of $150,000) and $25,000 more than you currently owe. With this scenario, $100,000 would
go to your original mortgage holder to completely pay off your mortgage. The remaining
$25,000 would go to you to use as you please (in this case helping your daughter with her
college expenses).
Going forward, you would only have one payment on your new $125,000 refinanced mortgage,
with interest tax-deductible (in most cases). Make sure you check with a professional tax
advisor before you deduct anything when you do your taxes. We hate saying "we told you so"
and we may just do that if you deduct from your income on your taxes without knowing if you
should or can.
In the end, it's really up to you whether you go with a cash-out refinance or a home equity loan
or home equity line of credit. All three have advantages and disadvantages, some just more
than others. In the current mortgage and real estate market, in most cases, a cash-out
refinance most likely is in your best financial interest, but check with your mortgage banker and
go over all your options before you make any decisions.
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Should You Refinance?
