It’s an exciting year for cash-out refinancing, which is expected to take a bigger share of the refinancing pie due to rising rates. In a cash-out refinance, your home is a piggy bank where you store and extract money from. When is the right time to refinance and withdraw cash out of your home?
When There Is Enough Equity
The equity you built in your home is one of the main deciding factors when doing a cash-out refinance. An ideal scenario is for your loan value to your home value (LTV) ratio reaching 80% or 85%. Depending on the lender and the type of mortgage, you may be able to borrow within that threshold.
With a cash-out refinance, you pocket the difference between your old loan’s balance and the new loan’s balance in cash.
For example, you have a $200,000 loan with a $160,000 balance and you’re looking to fund a portion of your child’s university costs or make an important home improvement worth $20,000. Your lender may give you a $180,000 loan with the $20,000 available for cash-out purposes.
When Home Values Are Increasing
The fastest way to build equity is when home prices are rising. The Federal Housing Finance Agency and the Federal Housing Administration have acknowledged this trend when they respectively raised the limits on conforming and FHA loans for 2017.
When you do a cash-out refinance, leave at least 20% of your home equity. This serves as a safety cushion for the lender in the event of default and for your future uses as well. If you borrow more than 80%, you may end up paying for a mortgage insurance.
When the Purpose Is Worth the Refinance
There could be various reasons why you decided to borrow against your accumulated equity. One of the most common purposes is debt consolidation.
Compared to paying debts using credit cards, taking cash out to pay off debts via refinancing comes with a lower interest rate. Plus, there’s a chance the home mortgage interest could qualify as a deduction on your tax returns.
When the Benefits Outweigh the Costs
Regardless of the reason, make sure it is financially sound enough to merit a refinance. The general rules of refinancing still apply to a cash-out refinance, such as:
- How long do you plan to stay in the home? Given that you have to open a new loan and close it with a new set of costs, you should occupy that home for a couple of years to recoup the costs and realize the benefits of refinancing.
- How long you’ve been in your loan? It would not make much sense to refinance if you are halfway into your 30-year mortgage. By that time, more of your payment goes to the principal than the interest. If you do take out a shorter-term loan, you can repay it faster at higher monthly payments.
- How are your credit, debt-to-income, and financial situation in general? If your credit has improved since taking out the loan, you may qualify for a lower rate, which is the goal of any refinancing. If not, you may have to negotiate with your lender or pay points. Lenders would also examine if your current income is enough to take on a new debt and if you are able to repay the loan given your present circumstances.
When those factors align, that’s the best time to do a cash-out refinance.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.
