When is a cash-out refinance the right choice?

Cash-out refinancing enables you access your home equity through a first mortgage instead of through a second mortgage, like a home equity loan or line of credit.

You will need to have 10% to 20% equity left after the refinance. The percentage needed hinges on the lender and whether you’ re willing to pay for private mortgage insurance (PMI) on the new loan.

A cash-out refinancing will not be a cost effective choice if you‘ ll have to pay PMI. PMI is an additional cost that borrowers typically pay when they can’ t afford at least 20% down payment to purchase a house or when they don’ t have at least 20% equity after a cash-out refinancing. It is used for protecting the lender in case you stop paying your mortgage.

Calculating How Much Money You Can Get from a Cash-Out Refi

How much money could you get from a cash-out refi? There are 3 factors you need to consider before calculating:

1. Home value of your house
2. How much you owe on your mortgage
3. How much equity your lender requires you to have left after refinancing (retained equity)

Lenders will use a physical appraisal or an automated valuation model to estimate the value of your home. You can borrow as much as 80% or 90% of that amount, depending on the lender’s requirements. The 10% to 20% of your home’ s value you can’t borrow is your retained equity.

From this new amount you can borrow, subtract what you owe on your current mortgage. The difference is the cash you’ ll receive. While it might feel like a payday to you, it’ s not taxable as income because it’ s a loan. Also, you don’t have to cash out the full amount your lender allows you to; you can take less. Otherwise you need to pay interest and fees on money you don’t need.

Cash-out refinancing pros:
• You can use the money for debt consolidation
• Interest rates are lower than HELs and HELOCs

Cash-out refinancing cons:
• Closing costs may higher than
• New loan will have a larger balance than your current mortgage
• Paying off your mortgage will take longer

When a cash-out refinance is a good idea

A cash-out refinancing is often best for homeowners who want to transfer their original mortgage to a convenient, lower-interest mortgage.

You may also be able to adjust the loan terms to pay off your home sooner.

For instance, if you had 20 years left on your 30-year loan. Your cash-out refi could be a 15-year loan, which means you’ d be scheduled to pay off your home five years earlier.

So, before you use a cash-out refinance, you should recalculate costs over the life of the loan, including taxes, origination fees, appraisal fees, closing-related costs.

That means you need to compare total cost of the new loan versus the cost of keeping your current mortgage for its life.

Remember that cash-out refinancing often involve higher closing costs, and they apply to the entire loan amount, not just the cash-out.

Generally, refinancing is only a good idea if you can secure a lower interest rate than what you pay now.