Borrowing against the equity in your home with a cash-out refinance can put extra money in your account when you need it most. But how do you know if it's the right move for you?
A cash-out refinance involves taking out a new mortgage loan and using it to pay off your old one. You borrow more money than you owe on your home and can use the excess to cover big expenses — like a home renovation or to consolidate high-interest debt.
Refinancing can be a strategic way to free up cash. And knowing the right questions to ask will get you closer to deciding if it's the right approach for you.
Cash-out refinancing involves borrowing against the equity you have built up in your home. Lenders will need to evaluate how much equity you have before approving a new loan.
"In order to be approved for a cash-out refinance, you typically need to have at least 20% equity built up in your home," says Cliff Auerswald, president of All Reverse Mortgage in Orange, CA.
To estimate the amount of equity you have in your home, subtract the balance of any loans you have against your home from your home's current market value. (When you apply for a home equity loan your lender will have your home appraised.)
Next, consider current interest rates before refinancing. With interest rates currently on the rise, this is an important factor to consider. Cash-out refinancing involves taking out a new loan to replace your old one, and your new loan will have a new interest rate based on current rates. The new rate can be higher or lower than your current rate and will affect the size of your monthly payment.
"If interest rates have gone up since you took out your original mortgage, it may not make sense to refinance," says Auerswald. "However, if rates have gone down, a cash-out refi could save you money."
If you choose to do a cash-out refinance, the size of your monthly payment will depend on a number of factors, including how much you've borrowed, the length of your new loan term and your new interest rate. To get a true sense of where interest rates stand, speak to a lender. Your rate will be determined in part by your financial situation, and a lender can help with the details on that and lay out associated costs to help you decide if refinancing makes sense for you.
"There are a few costs associated with refinancing," notes Auerswald. "They can include appraisal fees, loan origination fees and other closing costs."
Similar to closing costs paid on the original home loan, closing fees will be part of this new loan. If fees for closing costs are not available upfront, it's often possible to include them in the loan amount. However, this will make your monthly payment slightly higher.
To get an idea of costs, run some numbers in advance of meeting with a lender, use Citi's refinance calculator to get an estimate of potential savings and your new monthly payments.
With a cash-out refinance, the agreement is to pay the money back over the life of your home loan, usually 15 or 30 years.
"Before you decide to do a cash-out refi, think about your goals," says Auerswald.
Depending on your situation, some expenses, such as home improvements or paying down high-interest debt may make sense. Short-term costs like a vacation or a one-time purchase may not be worth a longer payback period.
Start with these four questions, connect with a lender and you'll be on your way to understanding if a cash-out refinance is the right financial move for you.
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