While buying a home is everyone’s aspiration, renovating, and repairing it requires money. In addition, many of us wish to purchase a second property but the down payments can be a bit hard on the pocket. In these and other situations, a cash-out refinance is a good option to fund your expenses.
Instead of taking a second loan, a cash-out refinance helps you to clear your primary mortgage, and replace it with a larger mortgage that not only clears the first but helps pay for your desired expenses.
In this article, we help you understand what a cash-out refinance is, in simple terms.
Cash-out refinance made simple
If you already own a home and have paid a portion of your mortgage, you can avail of a second loan. This loan is known as a cash-out refinance, and it can be used for a number of purposes such as:
- Debt consolidation
- Home repairs and renovations
- Down payment for a second property
- Personal expenses
Given that you have purchased a home on a mortgage, you will have paid monthly installments towards the principal loan amount. With time, your mortgage matures, and you will clear a substantial portion of your home loan. In financial and banking jargon, this is known as gaining equity.
Equity is the value of your home you in fact own. You gain equity when your home’s value increases, and also when you regularly make mortgage payments. A cash-out refinance is a loan that is given away based on your equity. It helps you to clear the existing mortgage in its entirety, plus receive a certain extra amount in your bank. In other words, a cash-out refinance replaces your older mortgage with a new one.
How does it all add up?
Let us imagine you’ve taken a loan of $250,000 to purchase your first home, and have cleared $90,000 so far by making monthly payments. You still owe the bank $160,000. Now, if you wish to make repairs or pay off your student loan worth $30,000 for instance, you can do so thanks to a cash-out refinance. Your new loan amount will be $190,000. It pays off the $160,000 you owe the bank, plus helps you with the $30,000 you need.
Use this handy formula to understand your own unique situation:
Cash-out Refinance = (Principal Loan Amount – Equity) + Your Expenses
Once your loan is approved and sanctioned, the lending institution clears the outstanding on your primary home loan and transfers the balance amount to your account in a few days. As your new loan amount will be larger, you’ll have to make your monthly payments for a longer time. However, cash-out refinance loans are comparatively cheaper than personal loans and credit cards as they have lower interest rates.
What lending institutions consider before approving a cash-out refinance
To make sure that you are able to pay your monthly installments on time without risks, banks and lending institutions often consider various personal risk factors. However, these factors make your application stronger:
- A decent amount of equity, as per the bank’s definition of what is acceptable
- A great credit score, which means, you make payments regularly
- Tenants living in your mortgaged property, assuring a regular rental income
- Your monthly payments are low when compared with your income (also known as Debt-to-Income ratio)
How to use a cash-out refinance smartly
- Use your cash-out refinance to make a down payment on a second property or invest in renovations and repairs. This increases the resale value of your house and attracts better-paying tenants.
- Utilize the cash-out refinance to put all your loans together, which finance consultants call “debt consolidation”.
- It can be very tempting to use a cash-out refinance for that trip you’ve always wanted or luxury furniture. However, it is a better idea to use it prudently.
Are you ready for a cash-out refinance?
Roses are red, and being in the red doesn’t have to be complex and difficult. A cash-out refinance helps you manage your debts better, meet your expenses, and save money on interest in the long term. Most importantly, you will be in control of your loans and savings.
Apply for a cash-out refinance today, and march towards a better financial tomorrow.