Is a cash-out refinance still a good idea right now?
- A cash-out refinance allows you to borrow against the equity in your home and use the money for other financial goals.
- The median home price in the United States has risen from $329,000 to $408,100 during the pandemic, giving homeowners plenty of equity to exploit.
- Now may be a good time for a cash refinance, as house prices are rising while mortgage rates are still relatively low.
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Mortgage rates are rising and therefore fewer Americans are interested in refinancing.
However, homeowners are also sitting on a lot of equity right now, thanks to the skyrocketing growth in house prices that has defined the pandemic housing market.
In the first quarter of 2020, the median home price in the United States was $329,000. In the first quarter of 2022, that number rose to $408,100, according to Census Bureau and Department of Housing and Urban Development data.
Since homeowners have gained so much in value over the past two years, many are well positioned to leverage their equity with a cash refinance, even as rates continue to rise.
How does cash-out refinancing work?
Like a rate and term refinance, a cash refinance replaces your current mortgage with a new one. With a cash refinance, however, you’ll be borrowing more than you currently owe on your mortgage and pocketing the difference. In most cases, you can borrow up to 80% of the value of your home. Here is an example of how it could work:
Your house is worth $300,000 and you still owe $150,000 on your mortgage. You decide to get a cash refinance for the full amount you can borrow, which is $240,000 (or 80% of $300,000). Once you pay off your current mortgage, you will have $90,000 (240,000 – 150,000 = 90,000) left, minus closing costs. These remaining funds are yours and can be used as you wish.
Mortgage rates are rising, but they are still relatively low
Generally, it only makes sense to refinance your mortgage if you can get a lower rate than what you are currently paying. Rates are now higher than the historic lows of the past two years. But they are still below their 2018 peak, when they almost exceeded 5%, according to data from Freddie Mac.
Plus, even when rates go up, a cash refinance is often cheaper than other options, says Melissa Cohn, regional vice president of Mortgage William Raveis.
“Mortgage rates are significantly lower than credit card debt or other types of loans,” Cohn said.
For example, while national mortgage rates are still below 5%, many people are paying well over 10% interest on credit card debt. And the lower your credit score, the higher your credit card interest rate could be.
Homeowners have earned a lot of equity during the pandemic
One of the main reasons cash-in refinancing can still be beneficial for homeowners is that after two years of rapidly rising home values, this group has plenty of equity.
Since market conditions have offered homeowners what essentially amounts to free money, it may be a good idea to tap into some of that wealth and use it to improve your financial situation, either by reinvesting it in your home, or by consolidating high-interest debt.
Sonu Mittal, head of mortgages at Citizens Bank, says he often sees people using cash refinancing for things like home renovations, debt consolidation or to cover large purchases.
“People can use the money for any of their financial needs,” Mittal said. There are no rules on how you can spend the money.
Although home renovations do not fully pay for themselvesvouchers can help increase the value of your home to some degree and increase your own enjoyment of your home.
A cash refinance can be cheaper than other options
Cash-in refinancing allows you to borrow money at a relatively low interest rate and pay it back over a long period of time.
Alternatives to cash-out refinance include home equity loans or home equity lines of credit, personal loans or credit cards. The best option for your situation depends on how much you need to borrow, how quickly you think you can repay the funds, and how much you’ll pay in interest and fees.
“If you are looking to use cash-out refinance proceeds in the near future for a home improvement, debt consolidation, or other life-changing event and you don’t expect to pay it back or pay it back significantly in two or three years, fixed rate mortgages give you peace of mind and reduce the impact on your monthly cash flow since you can amortize it over 30 years,” says Mittal.
The bottom line: If you can get a cash refinance with a lower interest rate than your other loan options, and you have enough equity in your home, it might be a smart move.