When Does a Cash-Out Refinance Make Sense?

Refinancing your home is a big decision. At Addition Financial, we often hear from homeowners who want to know if they should refinance. And if they do, they wonder if a cash-out refinance is their best option.

That’s an important question to ask – and one we can help you answer. Let’s talk about why you might want a cash-out refinance on your home. Then, we’ll review the pros and cons of getting one.

Does a Cash-Out Refinance Make Sense?

Should you get a cash-out refinance on your home? Let’s start by talking about what a cash-out refinance is and then, we’ll discuss some of the things you can do with the money you're planning to borrow.

A cash-out refinance is a way of borrowing against the equity in your home. It’s a type of second mortgage, and often, it’s a better way to pay for extensive home repairs or improvements than putting the expenses on a credit card.

You might need extra cash for a number of purposes, but let's talk about the two most common reasons why homeowners choose to get cash-out when they refinance.

The first is to make home improvements that will increase the value of your home. When you have equity, getting a cash-out refinance is a good way to use it and simultaneously increase your home’s resale value.

You don’t have to be planning an immediate sale for a cash-out refinance to make sense. You might be thinking ahead to the future when you will be ready to sell, but you don't want to wait that long to get cash out of your home. For example, some people undertake home renovations knowing they won’t be selling for many years, because they want to enjoy the improvements themselves.

Another common reason for a cash-out refinance is paying for college tuition. College is very expensive these days and for some families, using the equity in their home is the easiest way to afford tuition payments.

Of course, if you do this you won’t be adding to the value of your home. You’ll be taking on more debt without a potential increase in revenue. Before deciding to get a cash-out refinance for tuition, make sure you explore your scholarship, financial aid and student loan options completely.

There are many other reasons to do cash-out refinancing. You might have debt you want to pay off. The same cautions apply here as to using cash out to pay for college tuition. It’s important to make sure you don’t have other options before taking the leap.

Pros and Cons of a Cash-Out Refinance

Now, let’s look at the pros and cons of a cash-out refinance. Weighing these can help you make the best decision for you and your family. Here are some of the pros of taking out cash when you refinance:

• You’ll most likely get a better interest rate with a cash-out refinance than you would if you paid for home improvements with a credit card.
• The interest payments on your new loan will be tax deductible.
• Likewise, some of your closing costs on the refinancing may be tax deductible. We recommend consulting your tax preparation professional on this point and the one above, as this article is not intended to provide tax advice.
• You have options when it comes to using the money: you can make home repairs, pay off other debts or pay for a child’s college tuition.
• If you are making home improvements, you can easily recoup the cash-out when you sell your home.

Of course, there are some potential cons to consider as well:

• Your total mortgage due will increase by the amount of the cash-out you receive.
• Your monthly mortgage payments will increase due to the increase in your loan.
• You’ll be resetting the clock on your mortgage term – meaning that your loan term will probably change as a result of refinancing. Some people use refinancing as an opportunity to reduce the number of years remaining on the mortgage; however, reducing the term plus repaying the additional amount you financed may make it difficult to afford your new payments.
• Depending on the amount you cash out, you might end up owing more than your home is worth and that can impact your ability to sell it in a down-market.

That last con is one of the biggest. You’ll need to balance your need for cash against the current housing market. If the current value of your home is very close to the balance you owe on your mortgage, for example, you should be cautious about a cash-out refinance. A tumble in the market could put you upside-down and leave you unable to sell if you need to.

For some people, a cash-out option is ideal. For example, if you plan to use the cash-out to make repairs or home improvements that will increase the market value of your home, the added expense may be worth it. You’ll be protected – at least in theory – against the risk that you’ll owe more than your home is worth.

If you have some equity in your home and a good record of paying your bills on time, then applying for a cash-out refinance might help you.

To learn more about Addition Financial’s flexible mortgage and refinancing options, please click here now.