What is a Cash-Out Refinance?
A cash-out refinance is a mortgage-refinancing option in which an old mortgage is replaced by a new one with a larger amount owed on the previous existing loan. This ultimately helps borrowers use their home mortgage to get cash. When you opt for this option, you take out a new loan that’s bigger than your existing mortgage. The new loan amount is used to pay off your current home loan, and the remainder is returned to you as cash-back.
The Pros and Cons of a Cash-Out Refinance
If you’re looking to reduce one of your largest expenses, refinancing your mortgage could be beneficial. Smart investors will typically jump at the chance to refinance when lending rates are falling to new lows. However, as there is a variety of refinancing options available, it would be beneficial to check the terms of your mortgage agreement first.
A cash-out refinance is one of the cheapest ways to get cash in terms of interest paid. However, it comes with the high risk of losing your home if you can’t keep up with increased mortgage payments or the value of your home goes down.
Keep In Mind:
- Cash-out refinance rates are slightly higher than traditional mortgage refinance rates.
- Your refinance rate depends on your credit profile and how much cash you take out.
- You can typically cash out up to 80% of your home equity.
- Your new loan will be larger than your old one, so you’ll pay more in mortgage interest in the long run.
- Since mortgage rates tend to be lower than personal loan or credit card rates, cash-out refinancing could be a better way to finance larger expenses.
How Does a Cash-Out Refinance Affect Your Taxes?
Tax Rules for Cash-Out Refinances: You can deduct the interest you pay on your new mortgage from your taxable income if you use the cashed-out funds to make capital improvements on your home. Deduction-eligible projects generally include permanent additions and home improvements that increase your property’s value, extend its longevity, or adapt it for new uses.
How to Use Your Cash-Out Refinance Money So It’s Tax-Deductible: There are plenty of home improvement projects that you can tackle with your cash-out in order to claim the mortgage interest deduction.
- Adding a swimming pool or hot tub to your backyard
- Constructing a new bedroom or bathroom
- Erecting a fence around your home
- Enhancing your roof to make it more effective in protecting against the elements
- Upgrading windows
- Setting up a central air conditioning or heating system
- Installing a home security system
Keep in mind that these sorts of improvements are supposed to increase the value of your home. Repairs such as fixing a broken window or painting a room don’t usually count.
Do You Meet the Requirements?
Your lender sets their own requirements when it comes to deciding who qualifies for a refinance. Some of the most common cash-out refinancing requirements include:
- A credit score of at least 620
- A debt-to-income ratio of less than 43%
- More than 20% equity in your home
- A new appraisal to verify your home’s value
- A loan-to-value ratio of 80% or less
- Verification of your income and employment
Closing Thoughts
The window for yielding financial success from a cash-out refinance is becoming smaller and smaller. However, even with mortgage rates on the rise, the cash-out option may still be cheaper than other forms of borrowing like credit cards and personal loans. Borrowers who are looking to tap into their home’s equity for a cash-out refinance will probably be better off doing that now than waiting a few months since interest rates on those loans are likely to increase for the foreseeable future.
