Is a Cash Out Refinance a Good Idea?

Learn the Pros and Cons of Cash Out Refinancing

A cash out refinance lets you borrow money from the value of your home’s equity. With a cash out refinance, you replace your current mortgage with a new mortgage for a higher amount and get the difference in cash at closing. For example, if you have a $150,000 mortgage, you might be able to get a new mortgage for $200,000 and receive $50,000 in cash back by refinancing.

With home values rising in communities across America, many homeowners have the opportunity to get cash from their equity. Is a cash out refinance a good idea for you? Read on to learn more about the advantages and disadvantages.

What Are the Pros of a Cash Out Refinance?

Cash out refinances allow you to borrow money to pay for home upgrades, college educations, and other important expenses. Because the loan is secured by your home, the rates on cash out refinances are often lower than the rates on credit cards, personal loans, and other types of unsecured debt.

Cash out refinances may also have competitive rates compared to home equity loans and HELOCs. That’s because cash out refinances are considered "first mortgages" and home equity loans and HELOCs are considered "second mortgages." Since lenders often see second mortgages as having more risk, they may charge a higher interest rate as a result.

The money you get from a cash out refinance can help you pay for important goals. Consumers typically use a cash out refinance for the following:

• Home upgrades. You can use cash out refinances to make your home more comfortable and increase its value. Note that most home renovations do not give you a dollar-for-dollar return on what you spend. Learn more about home renovation costs and value.
• College educations. Paying for college and other kinds of education can help you or your family earn more money or advance your careers. Learn more about ways to pay for college.
• Debt consolidation. When you have high-interest debts, a cash out refinance can help you consolidate your payments and pay less interest. Learn more about debt consolidation.
• Business investments. Homeowners can use their equity to help fund a new business venture or other kinds of investments.

A cash out refinance gives you the opportunity to change the rate and other terms of your mortgage. For example, if you have 20 years left on your mortgage, you might choose to increase your term to 30 years or decrease it to 15 years when you refinance.

Finally, you may be able to deduct interest costs when you use the money from a cash out refinance to pay for home upgrades. Learn more about the tax implications of cash out refinances.

What Are the Cons of a Cash Out Refinance?

A cash out refinance will increase the amount of money you owe on your mortgage. It can increase the amount of your monthly mortgage payment. It will likely increase the total amount of money you pay in interest over the life of the loan. Cash out refinances have closing costs you will need to pay up front or add to your mortgage amount. Finally, a cash out refinance uses your home as collateral so you want to be sure you can afford the higher payments and other costs before you choose one.

Financial professionals do not typically recommend using the cash from equity for things like new cars, vacations, or other “nice-to-have” expenses. Instead, they recommend saving for these purchases rather than paying for them by increasing your mortgage debt.

Ask If a Cash Out Refinance Is Right for You

A cash out refinance can help you pay for home upgrades, education, and help you consolidate high-interest debt. If you are a homeowner with significant equity, you may be able to tap into that equity to get cash you need.

Freedom Mortgage is not a financial advisor. The ideas outlined above are for informational purposes only and are not investment or financial advice. Consult a financial advisor before making important financial decisions. By refinancing, the total finance charges you pay may be higher over the life of the loan.

Last reviewed by Freedom Mortgage, May 2024