Cash-out refinances put money in your purse at attractive interest rates. Lowering your monthly payment is also a popular reason to refinance your mortgage, but another reason is to use a refinance to get cash out of your home. When you have equity in your home—refinancing can provide a significant amount of money for home improvements, debt consolidation, education needs, and other goals. Although it is not risk-free, you should consider if the benefits outweigh the risk.

Pros of cash-out refinance

Debt consolidation

Debts consolidation makes sense intuitively, but you add a risk that previously didn’t exist when you do that. This can save you thousands of dollars. Debt consolidation is when you use the cash out from your refinance to pay off other liabilities and consumer debts.

Higher Credit Score

Using the cash out from your refinance to pay off other debts can increase your credit score down the road. Paying off the loan’s principal amount sooner can keep your interest payments low, which means less money is going out of your purse. This, in turn, can thereby boost your credit score, making your financial profile attractive to future creditors.

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Pay off higher-interest debt.

Like credit cards, several people often refinance to pay off higher-interest debt. Although the cost would undoubtedly be lower, you are very likely to extend the time it takes to pay off the debt. You’ll actually pay them off quickly if you just discipline yourself to make bigger payments on your current debts.

Also, note that you would be using your home to protect otherwise unsecured debts in this case. The credit card company can’t come after your private properties like your house if you default on a credit card. Your lender will certainly come after your house if you default on your refinanced loan.

Tax deductions

Another reason for a refinance cashout is that the interest on mortgages is tax-deductible.

Cons of a cash-out refi

Foreclosure risk
You can be at the risk of losing your home if you are unable to repay your loans.

New terms of the mortgage

You’ll restart the clock on all of your housing debt, so you’ll increase your lifetime interest costs as this will be a new loan with new terms.

Closing costs

Refinancing your mortgage isn’t a free process as a mortgage lender can include an origination fee, inspections, appraisals, and other expenses. Refinance closing costs can range from $2,000 to about $5,000, but this depends on the home’s cost and the area the house is situated. Although you can request a refinance with no closing costs, which reduces your upfront expenses but comes with a higher interest rate.

Private Mortgage Insurance

Homeowners who have less than 20% equity in their home when they refinance will be required to pay private mortgage insurance (PMI). If you are already paying PMI under your current loan, this will not make a big difference.

Pay off debt to run it back up.

Be aware that after the mortgage refinancing gives them the available credit to do so, a large percentage of individuals who once created high-interest debt on credit cards, vehicles, and other purchases will simply do it again. This causes an imminent quadruple loss consisting of wasted refinancing fees, lost house equity, additional years of higher interest payments on the new mortgage, and the return of high-interest debt until the credit cards are maxed out again. The potential outcome is an endless perpetuation of the debt cycle and eventual bankruptcy.

Tapping into Equity

Tapping the equity of your home has its benefits and disadvantages. This tapped cash, used wisely, may finance a high cost or pay off other high-interest debt. It can yield a bad return on your dollar when used poorly. And, if your higher home debt can’t be repaid, you may even lose your home.

Summary

Refinance helps you tap into your home equity to raise money to deal with a financial emergency, finance a large purchase, or consolidate debt. There are a lot of reasons homeowners refinance, such as:

  • To shorten the term of their mortgage.
  • To convert from one type of loan program to another, i.e., adjustable-rate mortgage (ARM) to a fixed-rate mortgage.
  • To get a lower interest rate.

Since refinancing can sometimes cost between 3% and 6% of a loan’s principal and require an appraisal, title search, and application fees, a homeowner must decide whether refinancing is a wise financial decision.

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