To better one’s financial situation or to make necessary house repairs, cash-out refinancing may be pursued. A home equity loan allows a borrower to take out a larger loan than their existing mortgage requires, freeing up the difference in payment to use for other purposes. This might include paying off high-interest credit card debt, updating an old kitchen, or funding a major purchase or new enterprise. Once you grasp the ins and outs of cash-out refinancing and know is a cash-out refinance taxable, it may be a very useful financial instrument.
The definition of a cash-out refinancing
In a cash-out refinancing, the existing mortgage is paid off, and the additional funds are taken in the form of a lump sum. One thing to keep in mind is that there are restrictions imposed by cash-out refinancing lenders on how much equity you may borrow.
If you owe $200,000 on a property that is worth $350,000, you have $150,000 in equity. Unfortunately, most cash-out refinancing programs only allow you to borrow up to 80% of your home’s value, so you would only be able to access $80,000 of your $150,000 in equity.
When I refinance, how much money will I be able to take out in cash?
Conventional borrowers can only borrow 80% of their home’s value, but military borrowers can borrow 10% more. Here are some popular cash-out refinancing options:
- Standardized Loans. Fannie Mae and Freddie Mac stipulate that borrowers may borrow up to 80% of the value of their homes. Plus, you won’t have to shell out money every month to cover the cost of mortgage insurance, which protects the lender from loss if you fail to make your mortgage payments.
- The Federal Housing Administration’s Mortgage Insurance Program. With an FHA cash-out refinancing, borrowers with credit scores as low as 500 may borrow up to 80% of their home’s value. The caveat is that no matter how much equity you have in the home, you still have to pay for costly FHA mortgage insurance.
- Loans for Veterans Administration Members. Veteran Affairs (VA) cash-out refinancing loans are guaranteed by the U.S. government for qualified veterans and active-duty service members up to 90% of the home’s value. Refinancing your VA loan for cash eliminates PMI. The VA will charge a 2.3% to 3.6% financing fee unless you have a service-connected disability.
Cash-out refinancing: the good and the bad?
Pros
- Any purpose can be served by equity cash-out. You can use home equity for debt consolidation or investment.
- This option’s interest rate is often lower than other home equity loans. Because mortgage rates are lower than a credit card, personal, and home equity loan rates, you can borrow more without increasing your monthly payment.
- Interest may be deductible. If you spend money on home improvements, you may get a tax break.
Cons
- 20% home equity is needed to qualify. If your neighbourhood’s house values have plummeted, or you made a minimal down payment, a cash-out refinance may not be possible.
- You’ll lose equity. If you borrow against your property’s worth now, you’ll have less when you sell it.
- Monthly mortgage payments rise. Even if cash-out refinancing is for debt consolidation, a larger loan amount means a higher monthly mortgage payment.
- Alternative refinancing solutions may have lower interest rates. A cash-out refinance usually has a higher interest rate than a rate-decrease refinance. If you’re accessing equity and have bad credit, expect a higher rate.
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