Whether it's for home improvements or debt consolidation, refinancing your mortgage may help ease the burden of cumbersome expenses, excessive debt, or a high-interest mortgage.
But there's more than one way to refinance a mortgage: Depending on your situation, you may want to consider a mortgage cash out. The answers to these frequently asked questions could help determine whether a cash out is the right refinancing option for you.
What is a mortgage cash out?
"The term 'cash out' is generally used to describe intent," says Keith Smith, a Regional Sales Manager at Regions Mortgage in Little Rock, Arkansas. A mortgage cash out is a refinancing option whereby your existing mortgage balance is ultimately replaced with a higher loan balance in order to provide cash that can be used for other purposes.
For example, let's say your home is valued at $200,000. You can typically refinance 80 percent of the home's value, which would be $160,000. From there, subtract your existing balance — mortgage and/or home equity loans (HELOANs) — to determine how much money you may receive with a mortgage cash out. So, using the above example, if your existing balance is $75,000, you may be able to receive $85,000 in a mortgage cash out.
Just remember that the amount you refinance, current interest rates, and the length of the loan may affect what you owe each month. If you're seeking the lowest monthly payment, Smith suggests looking for a 30-year term for refinancing. However, you will also pay more interest with a longer term loan.
What are the benefits of a mortgage cash out?
Like a typical refinance loan, a mortgage cash out can lower your interest rate, minimize your payment amount, or shorten the length of your loan. However, with a cash out you may also be able to consolidate debt by using the additional money to pay off higher-interest loans.
Alternatively, you may use the extra funds to make large improvements on your home or spend them on a major purchase. You'll want to read your loan terms carefully to make sure you understand any restrictions on how the money may be used.
What are the challenges associated with a mortgage cash out?
Because a mortgage cash out means borrowing more money, it will increase your existing loan amount. If you want to pay off the loan quickly, extending the length of your mortgage with a refinanced mortgage may be contradictory to your goal. There are also additional costs, such as closing fees.
Are there other loan options to consider?
If you find that a mortgage cash out isn't your best option, Smith suggests looking into alternative options like a home equity loan.
"With a home equity loan, rather than creating a new first mortgage, the customer typically takes out a second mortgage for a much smaller amount than the first," he says. "The closing costs can be substantially higher on a mortgage refinance than a home equity loan—the banker needs to really understand the customer's needs and long-term financial goals before recommending one option over the other."
If you opt for a home equity loan with little or no closing costs, be aware that interest rates may be higher and include a shorter payment term. Comparing the duration of the loans can help you understand which option is best for your situation.
"Getting the facts is key," says Smith. "A mortgage loan originator or banker can explain the cost of a traditional refinance and the many amortization options and help you compare those products to a home equity loan."
If you're still uncertain which option is right for your situation, consider the differences between a home equity loan and other debt consolidation options.
