Reasons for Cash Out Refinancing
Cash out refinancing is when you refinance your home and take out a loan for more than what you currently owe, and then you take the difference in cash. You can use this cash for whatever you want, but a cash out refinancing can be useful when used carefully and wisely. When getting a handsome amount of cash in a lump sum it can be difficult to practice self-control, but you really should be using that cash to invest in yourself long term. Before cashing out on your home’s equity, it is important to sit down and think about why you want to do this.
The most common reasons for a cash out refinance are:
- Home Renovation
- Paying Off Debt
- Starting A Business
- Purchasing A Second Home
Increasing The Value Of Your Home With A Home Remodel
The most common reason for a cash out refinance is to use the cash for a home remodel. While it seems at first glance that a home remodel is for personal gain, it is also considered an investment. A home purchase is one of the biggest financial purchases one can make in their lifetime, and remodeling it to update certain fixtures (such as a modern kitchen and updating the utilities to use cleaner energy) will also increase the home’s value. Unfortunately, home renovations are expensive no matter how “small” a project may seem, which is where a cash out refinance would come in handy. If you were to decide to sell your home in the future, you would be able to hike up the selling price for more than when you first purchased it. Not only is the value of property steadily climbing, but selling a home that is “move-in ready” could potentially tack on an extra 20% in the asking price because the buyer won’t have to do any necessary home remodeling. They would be able to cook and entertain guests starting on moving day. Investing the money into your home for improvements would help you to capitalize on your home’s value.
WARNING! – Do Your Research:
Before going to town and tearing down your walls to transform your home, make sure you do your research to see what kinds of renovations will increase your home value. There are such things as bad investments and all renovations are not guaranteed to spike up the value of your home. While it might have always been a dream of yours to have an indoor movie theatre or a luxurious bathroom, these might not appeal to everyone. It is best to stick to renovations that everyone will appreciate such as a repaired roof, insulation, or a new water heater. The more boring and logical the renovation, the better your return will be.
Pay Off Credit Card Debt
Another common reason for a cash out refinance is to pay off the majority of your debt. Having no debt at all would be ideal, but sometimes real life comes knocking at your door. People need to take out a loan to go to school or swipe a credit card in the event of an emergency. If you have debt that you need to pay off, a cash out refinance lets you tap into the equity of your home to pay it off. Paying off your credit cards would be the most ideal since the interest rates for credit cards are absurdly high, sometimes with 30% interest rates! You will find yourself getting out of your credit card debt very slowly if you are only paying the minimum payment, because most of your monthly payment will be paying off the interest charges. Many people don’t realize this, but when paying the minimum payment amount on a large balance with such high interest rates, you might never get out of debt. While you are paying off your credit card debt, you will still have to pay back the cash that you borrowed from your home. However, paying back your cash out refinance loan won’t give you an interest rate as high as credit cards, so you will still be in better financial shape. An additional benefit to paying off your debt with a cash out refinance is that your credit score will increase by reducing your credit utilization ratio- the amount of your credit card balance in comparison to the credit limit. Also, by paying your new mortgage payments instead of paying your credit cards, you could get a bigger tax refund since mortgage interest payments are tax deductible. Home loans offer a big tax advantage and this would reduce your taxable income, resulting in more money back during tax season.
Pay Off Other Debt
You could also use a cash out refinance to pay off other debt that you may have such as auto loans, student loans, or costly medical bills.
Fund Business Ventures
As mentioned before, using the money from your cash out refinance to invest in yourself is highly recommended. You also want to be smart about your decisions since your home is on the line. Using this money to invest or start a new business can be risky so again, think about why exactly you want to cash out on your home. If you have a great business concept and want to start your own business but don’t have the funds to get the operation going, this could be a way to get your ideas off the floor and get your new business up and running. Using the cash from your refinance as a down payment for a second home is more common since you could use that home as a rental property and increase your flow of income. You could even choose to live in the second home and use your current home as a rental property. The most important thing when deciding if this is something you want to pursue is to make sure that you have enough equity. This means that you will need to have paid off a decent amount of your home if you want to take out a large amount of money. There is a limit on how much cash you can take. Before, you were able take a loan for the full value of your property, but it didn’t end up so well. Nowadays, you have a limit of 80% Loan to Value Ratio so the more equity you have, the more money you can take. It is also important to note that simply because you need the cash does not mean you’re guaranteed to get approved for it. The best way to get approved for a cash out refinance is to have enough equity and have a good credit score.
Things To Think About
When using a cash out refinance to purchase another home, it is best to think of it as a long term investment. It is going to take time to see the return on your investment, so keep in mind that you won’t be seeing profits right away. Also, since a cash out refinance will most likely increase your monthly payment, it is important to calculate if your income from the rental property will be able cover the difference in your monthly payment amount. In order to even qualify for a cash out refinance, there are some things to consider. Since you will be adding more debt to what you already owe, it is important to show your lender that you have been consistently making payments on your original mortgage. Some cash out lenders require that you make payments for at least 12 months before you can even apply for a cash out refinance loan. Lenders might also give you a higher interest rate for a cash out refinance since you’re opting to take on more debt, therefore making it riskier for the lender.
You Won’t Be Getting The Full Amount
If you’re in desperate need of some cash right away, know that because you are still getting another loan, you will have to pay closing costs and closing costs can add up. You will have to fork over some of your own cash to pay for the legal fees and loan origination fees. If you need a certain amount for a particular project, be aware of how much these fees will cut into your lump sum.
A cash out refinance can be beneficial in numerous ways and there are definitely better ways to use it than others have in the past. In the end, using it as an investment for long term gain is the best way. No one can tell you how you use your money and you are at liberty to spend it however you like whether you want to spend it on a new wardrobe, a new car, or a long overdue vacation. Please keep in mind, however, that using that money on things that will increase in value is the best method since you will eventually have to pay it back with interest.