You may have seen the news recently, and you know that mortgage rates have fallen to historic lows due to the coronavirus pandemic. To reduce monthly payments, most borrowers will refinance when mortgage interest rates drop. You can also use the equity you have in your home with a cash-out refinance mortgage to pay for large expenses.
The pros and cons of a cash-out refinance mortgage
As with any financial move, a cash-out refinance mortgage has its pros and cons. Below are some of the pros and cons to help you decide if this type of refinancing is right for your needs. Continue reading to find out more.
Lower interest rates
Reduce other debts and improve credit
Tax deductions possible
1. Lower interest rates
Low-interest rates don’t only apply to new homebuyers. Historic lows are also available for mortgage refinance rates. There’s a chance you’ve been borrowing your home loan for a while and have not refinanced it in a while. You can take advantage of the low refi rates to get a lower rate on your mortgage.
Low rates are important when it comes down to your monthly payments. If your refinance rate is lower than your original rate, it may be possible to use the equity in your house while still making the same monthly payment as you are now.
2. Reduce other debts and improve credit
You can also take advantage of low mortgage refi rates by refinancing your cash-out mortgage. This will help you reduce other debts. This is where you borrow more money on your home than you owe and then the cash difference is paid to you in cash. You can spend the money however you like, even to repay existing debts, after the refinance.
Best of all, paying down your debts can help improve your credit score. Your credit utilization ratio (or the amount of credit you use compared to what you have) accounts for 30% of your credit score. Your credit score will rise if you have paid off all your debts.
3. Tax deductions possible
The IRS doesn’t consider the cash you receive as income when you do a Cash-Out Refinance. The IRS views the money instead as an additional loan. This means you might be able to deduct interest from your cash-out refinance.
Many of the tax implications, in this case, depending on how the money is used. The details of the home interest deduction are covered in IRS Publication 936. However, IRS Publication 936 explains that you cannot deduct interest for home improvements that significantly increase the value of your house.
The cons of a cash-out refinance mortgage
There are many benefits to a cash-out refinance, including the ones mentioned above. However, some things might cause you to pause.
Don’t take the chance that your home could be used as a bank.
1. Closing costs
The biggest drawback to refinancing your mortgage is the associated closing costs. Refinance is essentially taking out another loan to pay off the existing one.
You will be responsible for all costs associated with closing your loan, just as you did when you got your first mortgage. Your closing costs will typically be between 2% to 5% of your loan amount.
2. Potential PMI
You may need to budget for private mortgage insurance (PMI) depending on the amount you borrow. Lenders will require that you carry PMI if you own less than 20% of the home. Ask your lender about the impact of borrowing on your loan-to-value ratio to avoid paying this extra fee.
3. Don’t take the chance that your home could be used as a bank.
Finally, you risk seeing your home as a bank, ATM, or your biggest asset once you do a Cash-out Refinance. Refinance agents recommend that you only use a cash-out refinance for large, one-time expenses such as renovation costs or education costs.
The bottom line
Talk to a mortgage lender if you are interested in taking advantage of the current refinance rates and saving money on your mortgage payments while leveraging your equity in your home.