Advantages and disadvantages of cash-in refinancing

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The pandemic housing boom means American homeowners are sitting on a huge pile of equity. Lenders allow you to take some of that money out of your home through cash refinancing.

In a cash-out refinance, you cancel your existing mortgage and withdraw some of the equity in your home in one lump sum. As with any financial decision, a cash-out refi has advantages and disadvantages.

Refinancing by collection: advantages and disadvantages

Advantages

  • Access to a large sum of money: The biggest benefit of a cash-out refinance is that you get the cash you need to upgrade your home or pay off debt by unlocking the equity you already have.
  • Predictable payments: Most borrowers who refinance in cash do so with 30-year fixed rate mortgages. This means you know how much your monthly payments will be. This is not the case with other options for leveraging home equity – many home equity lines of credit, for example, feature variable rather than fixed rates.
  • Upgrades can increase the value of your home: Depending on the type of renovation you finance with your refi cash-out, the improvements could increase the value of your property and further strengthen your equity. Kitchen and bathroom renovations are particularly effective on this front.
  • Potential tax deductions: Renovations can also make a difference when you file your taxes. In general, you can deduct the interest you pay on the mortgage as long as you use the funds to make improvements that add value to the home. Improvements can also increase your tax base in the home, which will reduce your capital gains tax payable on the sale.
  • Mortgage debt is “good debt”: For most consumers, mortgage debt is the cheapest form of money available. Compared to credit cards, personal loans and other types of debt, mortgages offer a combination of low interest rates and favorable terms.

The inconvenients

  • You owe more: With cash refinancing, your overall debt will increase. No matter how close you were to paying off your original mortgage, the extra money you got to pay the contractor is now a greater financial burden. It also undercuts your product if you were to sell.
  • Closing costs: Just as you had to pay closing costs on your original mortgage, you will have to pay similar expenses when refinancing. These can be significant – credit check, appraisal and other costs can be up to 2-4% of the loan amount.
  • You need a lot of equity: Lenders generally require you to maintain at least 20% of your home’s equity (although there are exceptions) after a cash refinance, so if you recently bought on a low-payment loan, you might not. not be eligible.
  • You could get rid of your debts later: Financial experts say tapping into home equity to pay for renovations is a wise move. But if you’re cashing in to pay off high-interest credit card debt, take a long break. Make sure you’ve resolved any spending issues that got you into debt in the first place. Otherwise, you could end up in a spiral of debt.
  • Unexpected tax consequences: With a cash refinance, you take on additional mortgage debt, which can increase your tax liability. Be sure to consult your accountant.

When cash refinancing just isn’t worth it

If you’re concerned about the impact of cash-in refinancing on your long-term financial health, think about your future plans.

If you plan to sell your home in the near future, for example, it may not be wise to refinance a loan with a drawdown. After all, you’ll have to pay off the higher balance at closing.

It’s something of a gray area, though. If your kitchen is decorated with 1970s Formica countertops, vinyl flooring and wallpaper, then maybe using the proceeds from the cash in for the update will increase the value of your home enough. house to recoup costs.

At the end of the line

A cash-out refinance can be a smart way to pay for home improvements and renovations, but you need to have enough equity in your home and ideally get the lowest rate possible.

You can use Bankrate’s loan-to-value (LTV) ratio calculator to get a good idea of ​​how much you owe on your existing mortgage. Then you can add up your projected home renovation costs to see how much you need to turn your current home into your dream home.

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