If you’ve built up significant equity through your monthly payments and your home’s appreciation, a cash-out refinance may make sense to improve your general financial situation or the value of your home.
With a cash-out refinance, you’re refinancing your mortgage for more than you currently owe and, in return, getting a portion of your equity back in cash. Cash-out refinances generally have a slightly higher mortgage rate because you are borrowing more money, which is an added risk to the lender making the loan.
How does a cash-out refinance work?
- You purchased your home 10 years ago for $200,000
- You made a 10% down payment and secured a mortgage for $180,000 at 5.5%
- Through 10 years of making your monthly payments and paying down principal, you’ve built $30,000 in equity. Add the $20,000 you made as a down payment and you have $50,000 in equity
- Your home’s current value, based on comparable home sales in the neighborhood, is $270,000
You now have $70,000 (current value – original value) + $50,000 (built up equity) = $120,000 in total equity.
You decide you could use some of the cash you’ve built in your home to help pay for college tuition. With a cash-out refinance, you can receive a portion this equity in cash.
Let's say you'd like to take out $25,000 in cash, Your lender would add this amount to the current amount you owe on your home. This would result in a new loan amount of $150,000 (original loan amount – principal paid) + $25,000 = $175,000.
This loan will have new rates and terms and you’ll be responsible for all closing costs associated with the refinance.
Talk with your lender about whether a cash-out refinance is right for your situation, for the short- and long-term.