With interest rates on the rise, it might be wise to cash in on your equity before you miss out.
Let’s Start with the Basics – What is a Cash Out Refinance?
A Cash Out Refinance is when the homeowner will refinance their home for MORE than what they currently owe, and then take the remainder in cash. Think of it like a cash back transaction at your local supermarket or drugstore. You’re in line buying a pack of gum for $4.00 and decide that you want to get cash back for $20. The cashier will charge your card a new total for $24.00 and then you get to take the $20.00 in cash. In the end, you still paid for the $20, but you were able to get it in cash.
A cash out refinance is very similar to that. If you need money to put towards a home remodel, or to pay off high interest debt such as credit cards, you could get a cash out refinance to pull money from your home. After all, you’re putting money into your home every month. You should be able to get some of that back, if you need it.
What is Equity?
With a cash out refinance, you are able to get up to 80% of your home’s equity. Equity is the portion of the home that YOU actually own, not the lender. Since home values can go up or down, this means that your equity can also fluctuate. Remember the TY Beanie Babies doll craze? Let’s use that as an example.
Let’s say that you were early on the trend and you were able to buy the Princess Diana bear for $20. Later, the value for the Princess Diana bear spikes to over $100. This means that if you were sell it, you would be making a profit of at least $80. In this example, that means your equity is $100 instead of the $20 you originally bought it for. However, you don’t get to have that $80 profit unless you sold it and cashed in on the “equity.”
With homes, you are able to get a cash out refinance and get some of that equity without having to sell your home. You can still live in it and reap the benefits.
Timing is Everything
Like most things in life, timing is everything, especially with equity. Going back to the Beanie Babies doll example, if you sold the Princess Diana bear too early, you won’t get as much back than if you waited a little bit longer. It goes the other way, too. If you wait too long, you won’t get as much. Sometimes, you won’t get anything. If all of the sudden no one else is buying Beanie Babies, their value drops. If Beanie Babies continue getting unsold, they’re worth nothing and you overpaid for your Beany Babies doll because it’s now worth $3. The same thing goes for homes.
If the home’s value ends up going down so much that you now owe more than what your home is worth, you are underwater on your mortgage. People who are underwater on their mortgage have lost all of their equity and are not eligible to refinance.
No One is Safe from Rising Interest Rates
If interest rates go up, housing prices will eventually go down. Rising interest rates are put into place to fight inflation. The theory behind it is this: if things are generally more expensive to finance, less people will do it. With less people buying homes, the home prices will have to start falling because the demand isn’t as high. Most people won’t be able to afford the monthly payment for something that already costs so much, but also has a higher interest rate.
What people don’t realize is that rising interest rates affect everyone, not just home buyers. It affects existing homeowners as well, even if they have a fixed interest rate mortgage. When the prices for homes go down, your home’s value does too. And when your home’s value goes down, that means you’ve lost equity in your home.
The best time to get a cash out refinance is when home values are at their peak. With home values at a high, homeowners are able to pull more money from their homes to put towards expensive home renovations, a down payment on an investment property, high interest debt, expensive medical bills, etc. Getting a cash out refinance isn’t required, but if property values start declining, the option to get as much cash back from your home is no longer on the table.