Simply put, cash out refinancing is when you refinance your home and take out extra money on your home loan. It’s also called a cash out refi. So, why refinance? You can refinance your home for a lot of different reasons.
People typically refinance their mortgage loan to get a lower interest rate when rates are low. Since the market goes up and down quite often, it makes sense to pay attention. If you have already purchased a house… Paying attention to the housing market is still a good idea. Let’s look at some pros and cons of doing a cash out refinance.
All you need to know about cash out refinancing:
Let’s start with the basics: You buy a home. Like most of us, you don’t have the cash so you have to get a home loan. Home loans are typically long term loans so your monthly payments are affordable enough for you. Refinancing your loan means that you’re getting a new loan (mortgage) to replace your first. Therefore, the first loan no longer applies and is essentially paid off by your new, refinanced loan.
Cash out refinancing is similar, except you get cash back during the refinancing process. In order to do a cash out refi, you have to have equity in your home. The amount of equity you have depends on the current value of your house and the amount you’ve paid in to it. If the value of your home goes up and you pay off more and more of your loan… Your equity in your home goes up. This is assuming you’re paying off the actual loan amount and not just interest. Keep that in mind.
How much can you get? 
A lender will make a decision on how much cash you can get on a cash out deal. They will follow a protocol involving simple math on how much you owe versus how much your property is worth. First, you’ll need to get an appraisal. Secondly, they will typically want you to maintain about 20% of your equity. So, if your home loan is for $250k and the home is appraised for $250k, but you’ve paid off $150k… That means you have $150k in equity. You’re loan that still needs to be paid off is $100k. To maintain 20% equity, take $150,000 and divide by .20. That equals $30,000. Add that to the amount you still owe ($150,000) and you may be able to cash out $180,000.
This essentially means that you’re taking out a new loan to the tune of $280k. That’s the amount you’re getting in cash plus the cost you owe on the home. You can now see how this gets complicated real quick. While you’re interest rate may technically be lower than it was, now you have more to pay off. So, you will be paying more in interest, most likely. So, when you do a cash out refi on your mortgage loan when you refinance you home, make it count. You’re likely going to get a big check.
A lot of us simply aren’t good with money, right? We take on more debt than we should, spend beyond our means, and sometimes let companies take advantage of us. This is largely what happened in the 2008 crash. People were given home loans that they couldn’t afford by predatory lenders. This is something we want to discuss in regard to cash out refinancing. Let’s take a look at good reasons to do a cash out refi…
Good Reasoning
The best reason to get cash back on your mortgage loan when you refinance your home is… Putting the money back in to your home! In fact if you’re not planning on that, don’t do it. The main reason to take cash out on your loan is to improve your home/property. That way the value of your house will actually increase and over time your investment actually makes you money.
Bad Reasoning
Do not do a cash out refi if you want the money for any other reason than home/property improvement. This includes adding something to your home that’s unresearched. Adding a pool to your home in the coldest part of Alaska is not a good investment. Using the money to put a huge statue of yourself in the backyard… Also not a good use of that money.
Obviously these are extreme examples so let’s look at more common mistakes. A lot of people think that using cash out money for another unit on their property is a good idea. While it can be, you need to do research first. Whether it’s a tiny house, granny flat, or pre-fabricated structure; know how much it will cost, out the door, beforehand. Take in to account county ordinances, permits, building materials, taxes, etc. Most people think they can spend $50k and have a great little separate unit. That’s generally not the case. In a lot of areas, after permitting, contractors, builders, etc. a new unit will cost upwards of $150k. If you don’t plan properly, you’ll end up with an unfinished project that loses value as it disintegrates.
So, yes, there are a lot more reasons not to do a cash out refinance when you refinance your home. The main point is to treat it like any other time you get a loan; from a financially responsible position. Make sure it’s an investment you can afford. Use it to improve and provide continued value to your life. And most importantly, don’t do it without doing diligent research beforehand.
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