4 Situations to Consider Cash-Out Refinancing

Is a cash out refinancing right for you? If conditions are right, cash out refinancing can let you tap into the equity in your home and put that money to good use. Consider the following four situations when considering if cash out refinancing makes sense for you.

Cash Out Refinancing Defined

Before looking at situations when cash out refinancing makes sense, it's important to understand what it is and how it works. In any refinance loan, a homeowner with a mortgage takes out a new loan to pay off the first loan. The goal is to lower monthly payments through lower interest rates.

In cash out refinancing, the homeowner takes out a loan larger loan, than the balance of the first loan, pays off the first loan and keeps the remaining amount.

An example: Your home is worth $500,000. Your mortgage balance is $300,000. Your equity is $200,000. You refinance with a $350,000 loan, pay off the $300,000 mortgage balance and have $50,000 left for other purposes, plus $150,000 in equity.

Lenders typically require you to have been paying at least 12 months on the current mortgage and will lend about 75 percent of your home's value. In other words, you must have at least 25 percent equity in your home.

Adding Value to Your Home

Using the example above, if you take the $50,000 remaining from your loan after paying off the mortgage, remodel or add to your home and increase its value by more than $50,000, cash out refinancing makes sense. Often the increased value is only realized over time, so you want to be certain that the value will increase fast enough or interest rates have dropped enough, so that you don't end up paying in interest more than you make in increased value when you sell.

When Home Values Are Rising

Cash out refinancing can be a good option if home values in your market are rising and you believe they will continue to rise. Again, using the example above, if you take $50,000 out of your home and its value increases by more than that amount by the time you sell it, you have earned your cash out money back.

Often, when values are increasing, interest rates are as well. So if your monthly payment has gone up, you want to be certain the increased value of the home offsets the larger amount of money you pay in interest.

Consolidating Debt

Cash out refinancing can also help you reduce debt, particularly high-interest debt. If you can do a cash out refinance, at a lower interest rate than other higher-interest loan you have, you can use the money you take out of your home, pay off the other loans and give yourself a lower overall interest expense.

For Other Opportunities

When an investment opportunity comes along that you believe in, but you don't have the money to do it, cash out refinancing can let you take advantage of it.

If you qualify for cash out refinancing, the cash you take out of your home can be used for any purpose. You could simply spend it if you chose. But it makes financial sense if there is an investment opportunity with a rate of return that will outpace your home's increase in value.