What is a Cash Out Refinance?

Cash Out Refinance is taking a new mortgage on a property. It involves using the new mortgage to pay the existing mortgage, with any amount above the original mortgage going to the mortgagor. Basically, the mortgagor is cashing out some or all of the equity in the home and creating a new mortgage secured by the home.

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How Does Cash Out Refinancing Work?

When you need to borrow against your homes equity, you can either choose to refinance and withdraw the net value or take a home equity line of credit, HELOC. HELOC and Cash Out Refinance are different in a number of ways including:

Loan Terms

Refinancing pays your first mortgage; so, you'll have a new mortgage which may have different terms. This new mortgage comes with a different repayment period, different interest, and a new amortization schedule different from your first mortgage. In HELOC, you take an addition loan to your existing mortgage. This will be viewed as a second mortgage. The second mortgage does not repay the first. The second mortgage will have different terms from the first. If you have repaid the first mortgage in full, this second mortgage will act as your first.

Receiving Funds

In Cash Out refinance, you are given a lump sum when you get the loan. Here, the proceeds of the mortgage are used to pay off your first mortgage(s) including any associated costs and the remaining funds can be cashed out. . In HELOC, you are allowed to withdraw money from your line of credit during the draw period which is normally ten years. During the draw period, you will make monthly payments which will pay the principal and interest. After the draw period ends, you can no longer withdraw money and you start the repayment period. You will have up to 20 years to repay the mortgage.

Interest Rates

Cash-Out refinance is offered through a fixed rate or adjustable rate mortgage. You will be presented with both options and you choose which is affordable according to your situation. In HELOC, the interest rate is variable and dependent on an index, the US Prime Rate as will be published in the Wall Street Journal. The interest rate will increase if the index goes up and will decrease if the index goes down. However, your lender can offer a fixed rate mortgage that allows you to have all the remaining or a portion of the remaining mortgage to a fixed rate loan. This option is offered by Bank of America.

Closing Costs

Cash out refinancing incurs closing costs similar to your first mortgage, while a HELOC has no closing costs or has relatively small costs. Before you take either of the mortgages, talk to your lender and they will give you information on both mortgage options so you can choose the one that will suit your situation.

Benefits of Cash-Out Refinance

• Low interest rates Comparing this mortgage type to HELOC or home equity loan, HEL, cash out refinance often offers lower interest rates.
• Debt consolidation  You will no have two outstanding mortgages.
• Better credit history It may be used to consolidate debt and improve your credit score.
• Tax Refunds  Mortgage interest rates are tax deductible. With a cash out refinance, you reduce your taxable income and can even get a big tax refund.

Cons

• Risk of Foreclosure Your home is the collateral in any kind of mortgage. Increasing the debt owed increases the foreclosure risk.
• New Loan terms - You will have new terms for the cash-out refinance loan.
• Closing Costs As with any refinance loan, you will have to pay closing costs that are between 3 and 6 percent of the principal amount.
• Private mortgage insurance will be needed if you take a mortgage about 80 percent of the value of your home. PMI costs between 0.05 and 1 percent of the loan amount every year.