What is a cash-out refinance?

Only current or veteran military service members who want to tap into their home equity or refinance another type of mortgage are eligible for a cash-out refinance loan backed by the U.S. Department of Veterans Affairs. A VA refinance loan replaces your existing mortgage with a VA loan to refinance a non-VA loan and gives you the option to turn home equity into cash or refinance a non-VA loan.

There are other types of VA refinance loans, such as the VA Interest Rate Reduction Refinance Loan, also called the VA streamline refinance because a new VA appraisal is not needed, and the loaning process is simple. Although you cannot refinance a conventional loan or take out cash with a VA streamline refinance.

Pros and Cons of a Cash-out refinance

Just like most things in life, there are pros and cons of a Cash-out refinance.

>>More: FHA Loans: FHA vs. Conventional Loans?

Pros of a cash-out refinance

Debt consolidation

Many homeowners refinance to consolidate their debt. Although debt consolidation is a popular use, it is not always the best choice. If you apply for a cash-out refinance, you may be required to pay a higher interest rate on the new mortgage than for a rate-and-term refinance, in which you don’t take out money.

Higher Credit Score

You can save or use the cash out from your VA refinance to pay off your debts, thereby increasing your credit scores.

Pay off higher-interest debt.

You can cash into your home’s equity to pay off higher-interest debts. At face value, replacing high-interest debt with a low-interest mortgage makes sense intuitively.

Tax deductions

if you use the funds from your refinance cash out to improve your home, you may get a tax break that reduces your loan cost.

Cons of a cash-out refinance

Foreclosure risk

If you’re unable to repay your loan, you could lose your home. So taking out a cashout to pay for credit card debt is not the best. Unpaid credit cards are unsecured loans that cannot lead to foreclosure, but when you take a mortgage and are unable to pay, your house becomes at risk.

New terms of the mortgage

Whatever the terms of your previous or existing mortgage are, you and your lender will agree on new terms.

Closing costs

You always pay closing costs whether they are rolled into your loan balance. To close your loan, you can spend between several hundred to thousand dollars, and you need to add that amount to the costs of wherever you’re spending the money.

Private Mortgage Insurance

Private mortgage insurance usually protects the lender from borrowers who refuse to pay their debts. You will have a PMI If you borrow more than 80% of your home’s value. For example, when you refinance a home valued at $400,000 for more than $360,000, you might pay PMI. Private mortgage insurance can cost about 0.55% to 2.25% of your loan amount annually.

Pay off debt to just run it back up.

Tapping into your equity to repay other debts can be for you to enable your bad habits. A large percentage of people who once accumulated high-interest debt on credit cards, cars, and other purchases will run the debt back up after mortgage refinancing gives them the available credit to do so.

Tapping into equity

For a lot of people, their home is their biggest investment and most valuable asset. As such, it’s normal to consider tapping into the equity you’ve accrued when financial needs arise, and sometimes this is not the best decision that sometimes puts your home at risk.

SUMMARY

A VA cash-out refinance sometimes is a great financial move to reduce your mortgage payment, shorten your loan term, or help you build equity. When utilized judiciously, it can also be a valuable tool for bringing debt under control, thereby putting you on a better financial footing. You can also build equity by making renovations to your home. But seeking a refinance to purchase a new car or go on vacation is not always a good idea because those are not things you can earn money from.

Again, it is important to remember that refinancing will cost you 3% to 6% of the loan’s principal. It takes years to save that costs with the savings you will get with a shorter term or a lower interest rate. So in some instances, the cost of refinancing may negate any of the potential benefits that will accrue from refinancing.

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