Refinance is a mortgage taken to replace the existing home loan. A cash-out refinance gives you the option to replace your current debt obligation with a high value on the existing mortgage. The difference in amount is available for withdrawal in cash.
A cash-out refinance is generally taken to pay for home improvements or can be used for debt consolidation using the equity built up on the house. It is a better option in comparison to taking a traditional refinance. A cash-out refinance also has a slightly higher interest rate. The option allows you to take out a maximum of 90% of the home equity for expenses and debt consolidation.
Pros and cons
A cash-out refinance, or any refinance for that matter, helps lower the interest rate on your debt obligation. While you might be able to save on the interest component, paying for the closing costs after the tenure of the loan is still an inevitable expense.
When it comes to borrowing, a cash-out refinance is a better option for debt consolidation as you will pay a lower rate of interest. However, you may find it difficult to get used to the new terms and conditions of the loan for revised repayment.
You can use the difference in the amount to pay off your credit card bills. A cash-out refinance will also improve your credit score as a full payout tends to reduce the credit utilization ratio that directly affects the rating. In case you are unable to meet the new repayment terms and conditions, you run the risk of foreclosure of the property put up against the mortgage.
Taking a cash-out refinance significantly reduces your taxable income as the mortgage interest is exempt from taxation. You can expect a better tax refund in the process. However, you will have to pay for private mortgage insurance if the borrowing exceeds 80% of the total home equity. The tax implications will affect your taxable income and your refund.
A cash-out refinance may seem like an easy way of paying off your mortgage and your credit card bills. The refinance allows you to free up your credit limit significantly. However, taking out refinances over and over to pay off your debts is not advisable as you may end up racking huge amounts of credit card debt.